Helping the Owl of Minerva catch an earlier flight

Current Market Tactics

Yesterday I wrote that I won’t be posting so much for the foreseeable future. Here I am posting again, though.

Generally speaking, I think the way to formulate strategy is to formulate a hypothesis that you state clearly and then look for evidence that will falsify it. Straight out of Karl Popper.

Where are we now? What’s my current hypothesis?

Ten months ago, the S&P 500 and the US$ both surged after the surprise election victory of Donald Trump. The view then was that Republican control of both the White House and Congress would permit swift passage of corporate tax reform and allow large amounts of government money to be devoted to infrastructure repair/development. Such strong fiscal stimulus would allow the Fed to raise interest rates more quickly than the consensus had imagined.

As of today, the S&P 500 is up by 18% from election day; the dollar is somewhat weaker than it was back then.

It has become increasingly clear as time passes, it seems to me, that the country has been sold the “fiftieth-floor” penthouse in a building that’s only fifteen stories tall. Vintage Trump. One could also argue that the lack of economic organization and purpose that seem to characterize the administration are the same attributes that caused Mr. Trump’s real estate dealings to have been so spectacularly unsuccessful relative to his peers.

If so, we should expect giveback of last year’s market and currency surges as the market figures out the realities behind the campaign rhetoric.

That has already happened with the currency …which makes sense, since my experience is that currencies always run ahead of stocks.

S&P 500 earnings are maybe 10% higher today than they were a year ago, which would arguably imply a 10% rise in the index since then. That would leave the market 8% above the level I would pick for the S&P 500 if Mr. Trump were to prove to be a total bust as president. The 8% represents maybe 40% of what S&P 500 profits would gain from comprehensive tax reform. In other words, while I think there’s still a significant amount of hope in today’s prices that the Republicans can deliver on at least part of the Trump economic program, the lion’s share of the disappointment that we have a not-too-bright reality show actor–not a real-life real estate magnate–in the White House has already been factored into stock prices

Of course, there’s still that 8% …and we’re entering a seasonally weak part of the year for stocks. Absent concrete legislative progress on tax reform, I find it hard to see the S&P going up until we get to the end of the mutual fund selling season in late October. The best we can hope for is that we move sideways rather than down.

On the other hand, I’d be a happy buyer of secular growth and Millennial-oriented stocks with the S&P 5% lower than it is today. So, as always, a market decline would likely present an opportunity to upgrade holdings.

June 29, 2017

…toppy?

For the past week or so, the US stock market has been see-sawing, with a slight downward bias, between days when the tech sector is weak and financials/energy are strong, and days where the reverse happens.

If this isn’t exactly the countertrend rally I’d envisioned in my post early this month, it may actually be how computers act out a countertrend move in the algorithmic trading era. Whatever it is, it’s happening in spectacularly slow-motion fashion. My guess is that we either continue in this vein for the foreseeable future, or we have a more decisive downward move.

The economic/market situation seems to me to be what I described in my prior Market Tactics post. Tech stocks are as high as investors are willing to bid them until fresh earnings reports are announced; Trump stocks continue to await evidence the President is more than a not-too-bright reality show figure.

June 6, 2017

It’s almost four months, and +3% on the S&P 500, since my last Tactics post.

Several important investment variables are clearer today than they were back then:

–European economies continue to show strong cyclical economic uplift

–structural change in consumer spending in the US is gathering speed. Online vs bricks-and-mortar retail, for example, and eating at home vs. dining out. This is part and parcel of the economic baton-passing from Boomers to Millennials. We’re still in early innings

–evidence is building that Mr. Trump is not the answer to dysfunction in Washington. However, his election appears to have galvanized voters on both sides of the aisle to demand greater accountability from their congresspeople. So despite the growing conviction that income tax reform and infrastructure modernization aren’t on the menu for 2017, the administration’s lack of organization and focus are, I think, setting the stage for a further Washington shakeup in the 2018 elections. For domestic investors so far, then, Mr. Trump’s shortcomings = change deferred, not change denied

–externally, the view of Mr. Trump is not so rosy. But disapproval is expressing itself in weakness of the US$ rather than in a fall in the S&P 500. Given that half the earnings of the S&P are derived from foreign sources, the main result of this currency weakness is to help change the market’s sector focus rather than its price level

Where to from here?

I think sideways for the S&P for a while is the best we can hope for. I also think that’s the most likely outcome. All the running over the past few months has been in secular growth/structural change/ weak dollar beneficiaries. In my view, this is also the long-term trend. But it also seems to me that we’re overdue for a countertrend rally, which would benefit the Trump-agenda names that have languished since the inauguration. This would doubtless happen on any signs of managerial skill by the president. It may well happen by itself anyway.

February 16, 2017

Wow! It’s been a long time since I’ve had the urge to write a tactics piece. Yes, I’ve talked about tactics in other places, like Keeping Score. Still…

where to from here?

The S&P 500 is up by 4.9% so far this year, which is all the upside the brokerage house consensus had been predicting for all of 2017. Yet, the S&P shows no signs of flagging. That’s because we’re at full employment and most world economies–not just the US–appear to be on the upswing.

treading water, I think

My sense is that the US indices are beginning to flatten out, however. True, we continue to hear about new closing highs. But recently that’s mostly being achieved by tiny daily positive fluctuations.

To my mind, the stock market is waiting for two economic influences to become clearer:

—the Trump economic plan. So far the administration appears to have done nothing to implement its tax reform or infrastructure spending promises. I think the anticipatory rally that has been driving stocks higher since the election has already run its course. While equities may not fall back much while we wait, I think some action will be needed before we see upward progress.

—currency effects. This is a much more important issue than I think the consensus realizes. The US dollar is already significantly higher today than it was in November. In addition, some economists assert that imposing a value added tax on imports, which it appears Mr. Trump is advocating, could cause the dollar to rise by as much as 25%. That could easily offset most of the benefit of domestic corporate tax reform for multinationals. And it might derail the shift of labor-intensive, export-oriented manufacturing into the US (which I think is by and large a crazy thing to want). Without any details on what legislative changes are being proposed, it’s hard to separate potential winners from losers.

Until we get more clarity, I think the S&P will be range-bound around current levels.

August 12, 2016

higher highs ahead?

Recent stock market sentiment has turned markedly bullish, I think. There seem to be two main threads to the optimism:

–from a technical point of view, the market appears to some to look a lot like the early days of 2013. Back then the earnings growth outlook was lackluster (so, too, the subsequent actual performance). Still, the S&P rose by something like 30% in the subsequent 12 months

–every country in the world, ex the US, has the monetary taps pretty much wide open. This is arguably a situation arguably akin to having every bar in town offering free drinks for all. The eventual hangover may be massive, but in the meantime an epic party is in the works. One twist to this story is that the relative (certainly not absolute) tightness in the US might cause continuing US$ strength, implying relative sobriety here at home and the need to select stocks with currency implications in mind.

My thoughts?

–see the Current Market Tactics I wrote on July 15th (below)

–I don’t get the parallel with 2013 at all. The key feature of that year was that worries about a recurrence of the market meltdown of 2008-2009 dissipated. The result was that the market price-earnings multiple expended back to a more normal level from fear-induced lows. That won’t happen again, in my view.

–the idea that money around the world is easy has some merit. Also, the worst for emerging markets is arguably behind them; conceivably, so too for the EU in general and for bank stocks in the US. Bulls also argue that hedge funds have gotten this year’s market strength so far completely wrong, so when they get back from the Riviera and/or the Hamptons, they’ll be buyers.

I’m more in the slow-but-steady market rise camp, though. In addition, we’re approaching the annual mutual fund end-of-fiscal-year selling season, which typically begins in mid-September and goes on for several weeks. I’d prefer to do my shopping then.

July 15, 2016

new highs

In a very strict economic sense, a new high is just a number. It may mean little about the current state of world economies or the valuation of publicly traded stocks.

On the other, US stock market has been bumping up against a ceiling established about two years ago for a long time. So the break above it has at least a psychological significance in two ways:

–the sellers who have thwarted any previous attempt to break above the old trading range have run out of ammunition, at least for now, and

–short-term traders who use technical analysis as their guide have lost an important lodestar. For two years, it has been right to sell stocks as the market approached the previously impregnable ceiling of the old highs. Every failed attempt to break out to the upside made the barrier stronger. So selling just above 2100 on the S&P 500 was like shooting fish in a barrel. No more.

The practical import of reaching a new all-time high is that chart-driven traders no longer have any clear idea of where the current upside movement will/should meet resistance. This suggests they’ll be reluctant to try aggressively to stop the upward movement until they see the market slow of its own accord. So the current upward movement may have more oomph to it than one might expect.

where to from here?

For technicians, the old ceiling for the stock market now becomes a floor. Typically, the market works higher for several weeks before declining back toward the new floor to see whether it will hold under selling pressure. There may be two or three such “tests.” If the floor doesn’t break down under this assault, the market will likely begin to more upward again, on its normal two-steps-forward, one-step-backward path.

March 31, 2016

I’m beginning to think there’s a chance that we could break through to the upside as/when we get to 2100 or so on the S&P 500. As I’m writing this, the market is a bit more than 2% below that level.

This conclusion probably just shows that I’m keeping bad company these days and neglecting to think about longer-term strategy. Nevertheless, the possibility that the stock market could be breaking out of its year-long+ funk might have important implications, since there appears to me to be little resistance to further movement above the 2110 level.

Reasons, in descending order of importance for my change of heart:

–the dollar continues to drift lower against the euro and the yen. It’s now down by about 5% year-on-year against the former and 7% against the latter. This suggests that 1Q16 earnings from multinational companies have the potential to surprise on the upside. Even though the relationship is straightforward and the daily currency movements are there for everyone to see, my sense is that Wall Street really hasn’t noticed so far.

–portfolio investors seem to remain bearishly positioned. The amount of stock that has been borrowed and shorted is very high. Professional money managers appear to have become defensive when the market was swooning early in the year. Virtually no one has the courage to tell clients that he panicked and made a mistake. What happens instead is that managers wait to reverse course either until they assume clients have forgotten or until upward market movement forces them to move. If form runs true, long only managers are now positioned as defensively as they can be–and are no longer a source of further selling.

–the oil price has risen from its low around $26 a barrel early in the year. Very little of the stock market’s reaction to oil price changes makes economic sense to me. What’s clear, though, is that Wall Street likes $40ish much better than $25ish.

March 17, 2016

Happy St. Patrick’s Day!!

a change in stock market rhythms

Over the past short while, I’ve been noticing a bullish change in the rhythm of short-term trading in the New York stock market. It’s from what might be called “selling into strength (if any)” to “buying on weakness.”

More specifically, early in the year the market would tend to open higher in the morning, meet steady selling as it rose and would end the daily session down as selling continued in the afternoon while buying dried up.

Right now, the pattern is just the opposite. The market opens down, possibly on selling from investors abroad, stabilizes and closes up on steady afternoon buying. That’s as bullish a pattern as the prior one is bearish.

What has changed?

We’ve passed the seasonal low point for oil demand, for one thing. With gasoline at below $2 a gallon, demand for the motor fuel is up, year on year, in a surprisingly strong way in the US. Commodities traders seem convinced that the mid-$20 range for crude oil is going to be the cyclical low. In addition, the stock market itself appears to have formed a double bottom at around 1810 on the S&P 500 and is bouncing convincingly off it.

None of this necessarily has any strong long-term predictive value. But, then, it’s certainly a lot better than its opposite. Might as well enjoy the sunshine while we can.

On the sort-term horizon, I think the first obstacle we face is what happens as/when the S&P reaches 2110. As I’ve mentioned before, that has proved a formidable barrier to advance many times in the past.

I don’t want to guess what will happen when we reach the 2110 again. Nevertheless, I’m continuing to type away. 30+ years of stock market experience says to me that once it has become clear the market has hit strong resistance short-term traders will try to push the market back down until they find strong support (meaning sustained buying). My guess is that serious buyers could come back out below 2000–just how far below remains to be seen. On the other hand, however, in 2015 the S&P reached a top but went basically sideways for well over half a year. Although such behavior is very unusual, it’s also our most recent instance of behavior around a ceiling that’s difficult to crack.

–Suppose we’re in recession but don’t realize it yet. I find this hard to believe, but temperamentally I’m always bullish and therefore among the last to know that bad times have arrived.

If so, the most important issue is time. Even economic hiccups last at least six months and more likely a year. If the stock market is telling us that a recession began in early January, and if the market typically begins to react to positive news six months in advance, then we’re probably going to be in the current stock market funk until June. That’s plenty of time for stocks to have at least one more sideways-then-down movements (full-blown bear markets typically have three). This would mean it isn’t safe yet to adopt an aggressive posture.

–Suppose this is just a particularly ugly correction. That is to say, the issue the stock market is grappling with isn’t the health of the global economy but a perceived too-high valuation for stocks. Episodes like this play themselves out over four to six weeks. And since traders are more partial than long-term investors to the use of charts, support and resistance levels play a more important role in figuring out what’s going on.

If so, the 1810-1815 level on the S&P, a market low from April 2014, may play a role. The market touched 1812 intraday on January 20th and bounced back that afternoon to close at 1859. It touched 1810 yesterday and closed at 1829.

Typically, the market will have several “tests” of a resistance level like this. The more successful tests, the more strongly traders believe that a level where buyers are willing to step in–and therefore below which the market is unlikely to go–has been found. If 1810 isn’t the number, the next level seems to me to be around 1780. That’s less than two percent below where we are now.

what to do

Times like this are usually very good for upgrading a portfolio. Usually, long-term winners sell off the most in market downturns. Clunkers, which haven’t gone up much, if at all, in good times, tend to fare much better in market declines. Downturns allow us to switch from the latter to the former at relatively favorable prices.

If we’re in a recession, there’s no rush. If this is a correction, we should be making at least a healthy portion of switches we identify right now.

I’m in the correction camp.

I also think that the market has developed a morbid fascination for the oil price, thinking, incorrectly in my view, that it’s a signal of waning global demand (implying imminent recession) rather than of excess supply. Delusions can go on for a long time, however, which is another factor to consider. Still, my bottom line is that there’s no harm–and a lot of potential good–in doing portfolio housecleaning now.

A second, more widespread, delusion: thinking there’s no housecleaning to be done.

February 11, 2016

recession or not?

To some degree this question is aimed at gauging the possible depth of the current market selloff. Primarily, however, it’s aimed at trying to figure out its duration.

A garden variety recession-induced bear market typically lasts nine months to a year. It involves a decline in stock prices of maybe 25%. (Oddly, up days for the stock market usually outnumber down ones in a bear market. But the ups are tiny and the down days are like stepping into an open elevator shaft.)

There’s no sense in going on about recession, in my view, because there’s no evidence of one developing in the US. Yes, emerging markets have problems and the EU is, as usual, not the picture of health. But the US economy itself is not highly reliant on the rest of the world.

So no recession. In fact, the US is in the opposite situation. Given the constraints of an aging workforce and a federal government that may routinely subtract 1% from GDP each year, the US is in ruddy good health.

what else might be wrong?

–Base metals are in a prolonged period of oversupply, but that’s only a tiny segment of the market.

–Oil supply exceeds demand by 1% – 2%, which has caused a huge fall in the price of crude and refined products. Energy stocks represent 7% of the market and have been crushed over the past 18 months because of this. For oil using countries like the US, EU, Japan and China, however, lower oil prices are a substantial growth stimulus.

–the strength of the US dollar (plus imprudent tax policy in Washington) have caused domestic industrial production to slow and industrial profits to wane. If we include IT as industrial, this area represents about 30% of the S&P 500. Arguably, the outsized representation of such firms in the stock market is one reason equities are sagging while the economy is perking along. However, the dollar appears to have peaked against the euro, the main currency of concern for publicly traded companies, last November. It’s down by about 6% since then. 4Q15 earnings results will still be feeling the pain of the dollar’s rise, but it’s hard to believe the market’s so backward looking.

–banks tend to do well when interest rates are rising. To put this in (very) over-simple fashion, that’s because they raise the rates they charge lending customers faster than they up the interest they pay to depositors. So if a slowing industrial economy translates into a slower rate of increases in the Fed Funds rate, that implies disappointing bank profits. Financials make up about 16% of the S&P.

If we add all these problematic areas up, we get more than half the S&P. Part of the current decline may be due to the mismatch between the structure of the economy and that of the S&P 500. On the other hand, ex the banks, none of the items above have been new news for at least a year. In fact, one could reasonably argue that these factors explain why the S&P made no progress in 2015–and should have been discounted last year. Actually, this last assumption may be what’s wrong.

More tomorrow.

February 10, 2016

I haven’t dusted this page off in a long time. The post just below this , from last August 24th, came a day before an important market bottom. It makes interesting reading. I’m not as confident now as I was then, however, that we’ll see a similar bullish outcome.

the charts

The intraday S&P 500 peaked last November at 2126 (it had also hit roughly the same level in February, May and July of 2015 and been unable to advance). It hit a low of 1812, a drop of a bit more than 14%, on January 20th. After bouncing to 1947 (up 7.5% from the lows), it returned to 1835 yesterday–before closing at 1852.

One might argue that the bounce off 1835 is confirmation of the bottom for the S&P that was established on January 20th. My hunch is that the return to the lows has come too quickly to draw that conclusion.

So, overall, despite having put on my imaginary buckskin jacket and having channeled ancestors who were alive when technicals contained cutting-edge information, I don’t see anything that clearly indicates future market direction from the charts. Too much hope, not enough conviction.

the tone of current trading

Three characteristics:

–strong reaction, both positive and negative, to reported news. In other words, little of the market’s normal pre-announcement anticipation of events. This is what happens when the market is feeling bearish.

—extreme price reaction to both positive and negative news. This is unusual. Typically, investors react strongly to good news and ignore bad when they’re feeling bullish. They react strongly to bad news and ignore the good when they’re feeling bearish. The current pattern of reacting to both doesn’t give any clue to overall market tone.

–the “Tableau (DATA) effect.” DATA is a cloud company that reported last Thursday that its fourth quarter revenue growth rate had fallen from 60%+ to 30%+. The stock lost almost half its value in trading that day. At the same time, every other cloud stock was pummeled, not as badly as DATA, but still pummeled, as well. This rapid extrapolation from company to industry is also a bearish market trait.

Overall score: 2 bearish, none bullish, one neutral

More tomorrow.

August 24, 2015

What I diagnosed last week as a mild squall on the sea of stock investing has turned into a more serious storm.

The S&P 500 dropped through two technical support levels last Friday without much effort, closing down 3%+ and on the lows. Not a good thing. On the other hand, on a Friday in the late summer, many of the traders who might otherwise be buying are on vacation–and the rest wouldn’t want, as a matter of principle, to have stock on their books over the weekend. So they would have been active sellers during the final trading hour.

As I’m writing this at 9 am on Monday morning on the east coast of the US, Chinese stocks have fallen by 8.5% overnight, Europe is down by about 5% and the US appears set to open down by about another 4%. Ugly.

my thoughts

What’s unusual in the market situation now is not that stocks are declining–arguably a correction is long overdue–it’s the speed of the fall.

Has something fundamental happened in world economies to make stocks worth 7% less today than two trading days ago? My answer is no. If that’s correct, then the fall is resulting from a change of heart, to fear at least temporarily replacing greed as the dominant emotion driving investors, not from the onset of recession. The speed of the fall is an indicator of the depth of that negative emotion. Typically, deep negative emotion does more damage, and takes longer to dissipate, that milder feelings.

In times like this, I think there are three useful things to do:

–don’t give in to panic in the market. Put another way, trust the investment plans we’ve made during calmer days

–since stocks will be sold willy-nilly during a period like this, and clunkers typically outperform, it’s a good time to try to upgrade a portfolio by offloading losers and using the money to buy stocks we’ve wanted to hold but thought were too expensive,

–we can look at the charts and try to figure out at what level of the market the negative emotion will stop–what even bears will consider a good price to buy. Usually, this is a market level that has previously provided support. For the S&P 500, the next likely candidate would be the 1860 level, where the market began a rebound last October. That’s about 2% below where we are now.

August 21, 2015

It’s been a long time since I’ve made an entry on this page. That’s because 2015 has, so far, been a boringly flat year. So arguably no need to comment.

What has been unusual about 2015 is that the steady sideways movement has come during a period when earnings growth is negligible and at a relatively high market valuation–and with the very strong possibility of imminent interest rate rises on the horizon.

Under normal circumstances, we would be having a lot more volatility that we have been experiencing. That, of course, makes even a little volatility seem like the end of the world.

I view the current decline as a purely technical phenomenon. It may be something more serious, but the evidence to date seems to me to argue that this is a garden-variety correction in an ongoing upward market. That implies that it is an emotional storm, not one driven by fundamentals, ans suggests looking at technicals to decide how deep the fall may go.

On the S&P we’re right at a support line at around 2040. The next stop on the down escalator is 2000.

Assuming I’m correct, there are two things we, as investors, can do:

–watch relative price movements carefully, Thee’s information in which stocks are the strongest/weakest, and

–think about trades that we might do to strengthen our portfolios, since typically doggy stocks fare the best in corrections (they haven’t gone up, so why should they go down) and strong companies that have made sharp stock market gains sometimes fall the most (weirdly, many market participants don’t observe the rule that you ride your winners and sell your losers–they do the opposite).

February 13, 2015

In hindsight, 2014 was a straightforward year for investors in the S&P 500.

A year ago January, valuations were relatively full and earnings growth seemed unlikely to be robust because economies all around the globe were sputtering. Together, these implied that stocks were not going to run away to the upside. So riding big boring laggards like INTC or MSFT, that had high dividend yields and new managements trying to brush off the cobwebs seemed like a no-brainer. If I hadn’t badly misread what was in store for the Macau casinos, 2014 would have been a year to write home about for me personally, rather than just a mildly outperforming one. Yes, a lot of other stuff happened–the plunge in oil prices, the decline of the euro, Ukraine, continuation of the purge of high-spending elites in China. These had sectoral implications but by and large they didn’t make much overall S&P difference.

It was important in the second half, however, not to own oil stocks. But the flipside of that observation is that the return on the S&P, ex oil, last year was in the vicinity of +16%!!

the outlines of 2015 success

I think the outlines of what investment success will consist of in 2015 are now becoming clearer. Again, high-ish valuations suggest that full-year returns will be modest, even though worldwide economic activity looks to be more robust this year than last. But last year’s find-the-yield strategy seems to have lost its market charm. What I see instead is:

–find companies with secure, highly visible earnings growth. Take AAPL, for instance. As a company, it’s not in the class of FB or GOOG, in my view. But it has a rock-solid brand and, for the first time in a couple of years, has caught up to the competition with its main smartphone product. …plus it has never been able to develop much of a business in Europe. As a result, AAPL has strong, highly visible near-term growth prospects not strongly correleated with the general business cycle–and no danger of euro-induced losses. This is exactly what the market wants right now.

–avoid US firms with euro exposure. I’ve been saying this for some time. What has surprised me, though, is the difficulty the market has had in figuring out in advance that US companies doing business in the EU will have currency-induced losses. So the stocks go down when earnings are reported–not before. At some point, this factor will cease creating negative surprises, but that’s probably a quarter or two away. Hard to fathom, but that’s the way the market seems to be working.

–embrace structural change. I think this year will be less about finding relative value + yield and more about market-beating earnings growth. Tech + Millennials.

–patience and a willingness to trade (disclaimer at the end of the paragraph) will likely pay off. So far in 2015, S&P has exhibited continuous sawtooth action. My guess is that this will continue. Selling at the top of the rollercoaster hill and buying at the bottom (assuming we can perform this trick more than half the time) could garner us another 5%. Doesn’t sound like much in the general scheme of things–and it’s something I wouldn’t normally recommend. It’s also time-consuming. Still, for someone having, or willing to acquire the knack, small gains may make a big performance difference in a year when a +10% showing could put you deep in the top quartile of professionals (as I’m writing this, I’m realizing I’m going to do this, but that it’s probably not the greatest idea for anyone else).

Two factors that might change my mind–toward the upside–on the market:

–news out this morning suggests that the combination of a lower euro + the fall in oil is giving Continental Europe a shot in the arm. Upward movement of Chinese port stocks suggest this as well. Euro-based multinationals are already interesting, in my view. But there may soon be a reason to look more deeply into the domestic side of European markets. At some point, euro exposure may not be so offputting in earnings releases of US-based multinationals.

–there are very early signs that the anti-corruption campaign in China is past its worst. This would eventually be a big plus for high-end consumption, although changes in local tastes may mean different beneficiares than in the past.

Either development would have a positive ruboff effect on US stock values. I don’t think either calls for a fundamental overhaul of portfolio structure, though the possibility of higher index gains diminishes the attractiveness of an active trading strategy.

January 6, 2015

I can see three reasons for the selling that has greeted world stock markets after the year-end holidays:

–taxable investors sell their losers in December. They nurse the winners they have earmarkeed for sale into January and dump them then. Just looking at how last year’s big gainers are performing tells me there’s now tax-related selling going on. I think this is the least important factor, however.

–the consensus view of prospects for the S&P 500 in 2015 is about the same as the outlook for 2014 was a year ago–maybe a somewhat smaller advance. Let’s say the idea is that gains will be more than 5% but less than 10%. On top of that, this year’s figure is subject to a lot of uncertainty, given the anticipated beginning of Fed rate raising, craziness in the EU and falling oil prices. And stocks are 11%+ more expensive than they were a year ago (well, after yesterday, 9% more expensive).

Last year the S&P had three price declines of 100 points or more. If 2015 is going to be more or less 2014 writ small, then potential buyers are probably thinking there’s no rush to put new money to work. Personally, I think so. I figure stocks are not going to run away to the upside and this bout of selling might create the chance at a 10% – 15% gain on an individual stock. That may not be lifestyle changing, but it’s better than 5% – 10%. So I’m content to wait for better value.

–falling oil prices. Some economists are (still) saying that the decline in the oil price is an early warning of a sharp falloff in global growth that’s now starting. In other words, oil is not down because of excess supply. It’s lower because the world is entering recession. This argument is based on statistical correlation studies that show a direct relationship between economic growth and the oil price.

I think this idea is wrong …but I also think the possibility is the market’s main worry right now. More on oil tomorrow.

what to do?

I’m doing two things: monitoring stocks I’d be happy to buy at somewhat lower prices, and combing through my holdings for stocks/funds to sell, that is, ones which have either worn out their welcome or fulfilled their potential. It’s my experience that there’s always some potential underperformer quietly nesting in a hidden corner of even the best portfolios. Might as well find and get rid of it now.

October 17, 2014

correction over?

…it looks like it to me. Here’s why:

–from the intraday high for the S&P 500 of 2019 on September 19th to the intraday low of 1820 two days ago, the index fell by 9.9%–meaning the loss has been significant

–the decline played out over several weeks, a considerable amount of time–and a long period to remain fearful

–on Wednesday, the market temporarily broke below important support for the S&P 500 at around 1850

–the breakdown occurred on high volume, and

–it almost immediately reversed itself, with the market closing that day at 1862–perched on/above the support line.

This sequence checks off all the boxes for a typical emotionally-charged, chart-driven correction in the US. In particular, Wednesday’s scary intraday breakdown is the classic way American corrections end.

In a completely rational world, nothing like this would happen. But financial markets aren’t 100% rational. They’re also an arena where the madness of crowds occasionally plays itself out.

I have no explanation for why the pattern I’ve outlined above plays itself out again and again. But it does. More curious, this sequence is not universal. In Hong Kong or Tokyo, for instance, my experience is that when an important support level is broken, the index promptly drops like a stone. In the US, on the other hand, a peek over the edge of the cliff often stops selling rather than accelerates it.

To be clear, I’m not a fan of using charts as an investment tool. Charts have been supplanted by spreadsheets. I regard technical analysis generally as a relic from a long-gone (in the US) era when companies provided only scanty financial information and when investment bank-led syndicates shamelessly manipulated stock prices to the detriment of ordinary investors. Nevertheless, charts can give a good read on sentiment during emotionally charged times like we’ve been experiencing (in a small way) over the past few weeks.

October 9, 2014

caught in the headlights

The S&P 500 has been ratcheting down in sawtooth fashion since mid-September. What I find particularly noteworthy is not the overall movement–after all, the stock market is always a two-steps-forward-one-step-backward affair. Rather, it’s the strength of the daily or even intraday movements, both to the upside and the downside. More than that, moves in one direction are followed by headscratchingly rapid reversals.

I think two factors are at work:

–from the market bottom in March 2009, stock markets around the world have had an upward bias. From that point on, equity investors have had both increasing earnings generated by stronger economic activity to drive prices higher, as well as restoration of valuation from the depressed levels set by panicky, throw-out-the-baby selling in 2008-09.

Today, we’re back to normal market operation. Economies are as good as they’re going to get. And in their usual fashion, equities have not only discounted in current prices expected 2014 earnings but also a portion of what Wall Street has believed 2015 will hold in store.

Wall Street is now having second thoughts about next year.

Weakness in continental Europe suggests that in 2015, the dollar will be higher–and therefore foreign-sourced earnings lower–than the consensus had expected. Yes, interest rates will probably also be lower, but Wall Street had been thinking that, in line with historical precedent during times of monetary tightening, the level of interest rates wouldn’t affect stocks that much. So the new factor that equities are digesting is somewhat lower earnings.

Personally, I think that the major effect of a higher currency will be a change in the composition of higher earnings, meaning which firms will have them, but for now that’s a little too subtle for Wall Street’s taste.

–the (sensible) move from active management to index funds and ETFs has lessened the influence of active investors with longer-term horizons in the daily trading arena. Yes, as a whole these investors may have lost money to the index, but we may be finding that they provided a (now-absent) stabilizing influence on short-term trading. As well, the firing during the recession of many veteran sell-side analysts, who were deeply knowledgeable about the companies they followed, has left the door wider open for short-term players who trade on emotions, instinct and charts rather than reasoned expectations of future earnings.

I have no idea how much of the current herky-jerky movement of the S&P to assign to each factor. My hunch is that the downward direction comes from the first, the daily volatility from the second.

Whatever the case, I suspect that this is the world we’re going to be living in from now on. I don’t think the greater volatility has much significance, other than that careful investors will set buying targets lower and selling targets higher than they would otherwise. And, as I’ve said for a long time, the rewards to careful fundamental analysis of individual companies should be higher than it has been over the past, say, twenty years.

As to overall market levels, I’m reduced to looking at charts. They say to me that the first important support level for the S&P is at 1900. We got to 1934 in the early afternoon yesterday, before rebounding on traders’ reaction to the Fed’s latest meeting minutes.

Whatever the short-term market fluctuations may be, the main point is that we have to become accustomed to a bumpier road, while remaining focused on the stocks we own.

September 26, 2014

The S&P 500 entered the month at 2003. It reached a high of 2018 on the 19th. It’s around 1967 as I’m writing this, early in the New York trading day.

In other words, stocks have recently been choppy within a narrow range.

The more significant move this month has been in currencies, where the US$ has gained close to 4% vs the € and almost 5% against the ¥.

What to do?

The currency part is straightforward. I don’t think there’s any reason for the current trend of dollar strength to reverse itself. So, all other things being equal, we should be looking to buy companies whose costs are in euros or yen but whose output is sold in dollars–and to sell those in the opposite situation.

I think the bulk of the near-term currency move is behind us. This is typically when stock beneficiaries of currency begin to move.

Otherwise, the stock situation is a little more complicated:

–the S&P has gained 6.8% so far this year. Throw in dividend income and the total return is closer to 9%. The index is now trading at 18x this year’s earnings and 16x anticipated (by me) 2015 results. Gains so far in 2014 have handily exceeded strategists’ expectations.

I think all this adds up to the market being fairly valued, meaning there’s a 50/50 chance of the index going up or down.

–For decades I’ve been waking up to reports of pre-market trading in stock index futures. For the past five years, my expectation has been that I’ll hear every morning that futures are up. A couple of weeks ago, I realized that I no longer have that expectation–an emotional/unconscious conviction (for what that’s worth) that we’re finally back to “normal” post-recession market operation.

–I think the chances of a sharp downward market movement are slim. That’s because the current level of monetary stimulus being applied by the Fed is immense, and because the Fed says it’s going to be moving super-slowly once it begins to move back to normal next Spring. The Fed already has a blueprint of what not to do in the actions of the Japanese government in the 1990s.

My conclusion:

–there has been a lot of industry and individual stock movement below the relatively placid surface of the S&P. Trade the price discrepancies that are being generated. Buy stocks that have been unjustifiably beaten up.

I’m getting the money by trimming positions that have done well and starting to jettison names that haven’t moved the way I’d anticipated. This is mostly a question of relative value, although it’s also a bit of yearend housecleaning begun early. One of the most surprising (to me, anyway) areas of decline has been among the Hong Kong-traded Macau casinos, many of which are now trading a 5%+ dividend yields (just don’t buy the Ho family-related names).

August 20. 2014

having too narrow a focus

As the post below this one shows, I’ve been confused about recent stock market action in the US. Valuations seem high to me. Company fundamentals are ok, but not great. I wasn’t seeing stuff to buy.

Two changes in the past week.

I’ve started looking harder, and have been finding oddball stocks that I an at least tolerate–meaning I think they have a good shot at +15% – +20% over the next year. In baseball terms, they have zero home run potential but they play decent defense and are steady singles hitters (doubles? …maybe, but not likely).

More importantly, I’m starting to think that I’m looking at the US stock market the wrong way–from the inside rather than the outside.

best of a bad lot

Excluding emerging markets, an investor has three basic equity choices. He can invest in North America (mostly the US), the EU or the Pacific (predominantly Japan). Here’s how the three areas stack up:

the US is ok but kind of pricey

Japan is amess. It’s very clear–as if there was ever any doubt–that corporate Japan won’t change its profit-unfriendly samurai ways, and the the government won’t remove the legislative protections for managements put in place in the 1990s. Then there’s the increase in the national value-added tax–straight out of the country’s let’s-keep -the-recession-rolling playbook of the same vintage.

The EU has an economic growth pulse, but just barely. Normally, geopolitics is great for cocktail party conversation but has very little stock market relevance. Russia/Ukraine is different, partly because the EU and Russia have close enough economic ties that trade sanctions hurt, but mostly because parts of the EU are close enough to intensive care that even a little push may land them in the hospital.

In sum, especially to a foreigner, the US looks pretty good.

look at currencies

Over the past month, the dollar has been steadily rising against both the yen and the euro, gaining 1.5% against each over this span. I don’t see why the dollar won’t see further strength. To me, this means it’s time to start looking for EU-based multinationals with large exposure to North America. I’d say the same for Japan, except that these may be undermined by a dreadful domestic economy.

To a lesser extent, this also means being wary of US-based multinationals with exposure to weak foreign economies. But these may be bailed out by better-than-expected US results.

August 13, 2014

We’re in a very peculiar stock market environment at present.

Three characteristics:

–I can’t find much to buy. I have stocks I’m content to hold, but I’ve begun to consider chemicals firms and the dregs of the commodity semiconductor industry–two areas I consider the least likely for a growth investor to dabble in. Maybe I’m just missing something, but…

–S&P Indexology says that companies generally reported higher-than-consensus results for the June quarter. Given the overall improving economic tone in the US, that shouldn’t be too shocking. Nevertheless, the market reaction to company announcements was the opposite of what I would have expected. Companies that reported positive earnings surprises did nothing; companies that reported disappointments were destroyed.

This is classic down-market behavior–investors ignore good news and only focus on the bad.

–Nevertheless, stocks don’t seem to want to go down. They don’t give much indication of wanting to go up a lot, on the other hand.

What to make of this situation?

I’m not sure. What I’m doing is becoming more defensive. My dilemma is that I think stocks will be higher a year from now than they are today. That’s because economic growth will be stronger–and corporate profits 15%+ higher than they are currently. History says we can’t get there from here without a market correction. Yet I’m uncomfortable with raising cash in anticipation, since experience (read: history) tells me that’s always a losing strategy.

July 9, 2014

back to neutral

Last Thursday the Bureau of Labor Statistics published a blockbuster Employment Situation report. If anything should have gotten the market moving upward, this would have been it. Instead, the S&P rose by about half a percent in abbreviated pre-holiday trading, and has fallen the two subsequent trading days. In addition, Wall Street’s make-up/break-up romance with smaller speculative “concept” stocks, which had been in the former mode for most of June, appears to have reverted again to the latter–where the relationship had been from February-May.

Yes, it’s possible that as a result of the June ES the Fed will begin to raise interest rates a month or two earlier next year than it might otherwise have. On the other hand, forgotten in the current hand-wringing, is the object lesson that a quarter-century of stagnation in Japan offers of the perils of tightening policy too soon.

Personally, I think that what’s happening is a lot simpler than a change in the market’s consensus macroeconomic forecast for 2015.. I think that investors have looked at the S&P at 1985, observed that it is now trading at 18x this year’s earnings and maybe 16x next year’s, and decided that the chances of making short-term gains from here are poor. How likely is it that new money committed to stocks at 1985 will make me, say, a 10% return by yearend? The market’s answer (mine, too) is–not very. a 5% return? –maybe, but don’t bet the farm.

Therefore, the market will back off until it reaches a level where a return between 5% and 10% is likely. This is the January 2014 market all over again.

High-flying ” concept” stocks that soared last year, sold off from February to May and then rocketed up again in June are selling off once more. My guess (for which I have no evidence) is that hedge funds who were aggressively shorting baskets of these stocks a few months ago are doing it again. This is not the market I grew up in, but it’s a fact of life in a world with a large pool of short sellers.

If I’m correct, I’d expect shorting could push such stocks down to within a few percentage points of their month-ago lows. That, I think, would be a good entry point for you and me.

June 11, 2014

drifting higher

After treading water for a couple of months, the S&P 500 has been drifting higher for the past three weeks or so. I have no idea why, other than the generally unsatisfactory observation that markets seldom move sideways for long periods. They either go up or down. And this one has decided not to go down, despite the opportunity afforded by expansion of the market multiple to almost 18x, worries about Ukrainian instability, a sharp selloff (now ended, I think) in formerly high-flying concept stocks and market rotation away from last year’s winners. We can see this in four unsuccessful attempts by the S%P to go below 1860.

The only factor I can see is one I’m not an expert in–the extraordinary decline in the yields of sovereign bonds outside the US so far this year. The Financial Times is now observing/complaining (e.g., “EM bonds: are you nuts?”) that even government bonds in highly unstable countries in the Middle East are being gobbled up like there’s no tomorrow. Not so in the US, where bond market participants have begun to discount future normalization of interest rates. Nevertheless, US yields must be influenced by demand for comparable government securities elsewhere.

In other words, the fact that the German 10-year bond yields a mere 1.40% and even the Italy(!!) only 2.80% is keeping US Treasury yields from rising. That factor, in turn, makes US stocks look mare attractive.

a market of stocks

That’s one way Wall Street commentators express the stock market transition away from highly economically sensitive stocks, which typically star in the early period of recovery from recession and which run in sector packs, to more secular growth names, which take up the running one by one when the economy recovers its equilibrium and begins to expand again. After a garden-variety recession, this inflection point comes after eighteen months or so. Post the Great Recession, I think we’re really just getting to that point now. Individual stock attributes count more than industry classification.

waiting for July?

Another possibility for recent market strength is that stock investors are beginning to discount economic prospects for 2015, when S&P 500 earnings are likely–to pluck a number out of the air–to post a 15% gain over this year’s tally. Maybe half of that 15% would typically be factored into stock prices this year. My sense, though, is that this isn’t happening yet. It’s the wall of money flowing into bonds that is raising stock prices.

That would be a good thing, if I’m right, since it would imply that this potential boost to stocks is still to come.

what to do

Year to date, the S&P is up by 5.2%, most of that return achieved during the past few weeks. I don’t expect the second half of the year will play out much differently than the first. For some time, I’ve been advocating picking through the rubble of the fallen “concept” stocks. I also favor IT. But I think the market story will continue to be either individual growth stocks with strong earnings, or their more mature brethren with moderate growth and high relative dividend yields.

April 16, 2014

We’re in a strange, Twilight Zone-like market in the US at present.

Most stocks have been more or less holding their own. A few, like HPQ or, to a lesser extent, INTC, have been doing better than that. But many recent IPO rocketships have reversed direction and are plunging back to earth. Selling has also gradually spread to high PE stocks of any stripe. The biggest losers are what are typically called concept stocks, where meaningful earnings are far in the future. But not all are in this camp. For, say, AMZN, the paucity of EPS is partly a function of very conservative accounting technique.

Redeeming features haven’t mattered much. All have been bludgeoned in trading most days for about a month. Many have lost 20%+ from their highs. Some have lost considerably more.

It’s not clear what set the selling off, but it usually isn’t. Maybe it was the TSLA convertible bond issue, which was heavily oversubscribed and in which “investors” agreed to take a very low coupon in return for the right to buy TSLA shares at $350 each, or something like 70x earnings five years from now. Someone concluded that it can’t get any crazier than that and began to sell. That triggered a landslide of sell orders.

We’ll never know for sure. However, I think it’s time to start nibbling at some of the stocks that have been sold off the most aggressively. I’d even think about rebuying the TSLA I sold at $175 a while ago.

I’m not saying anyone should make a major commitment to former market darlings. But I do think that it’s ok to add small positions in one or two.

I’m not in a rush, either. I’m looking for two things that appear to me may be falling into place:

1. I’m waiting for the market to settle. So far, there’s been little downward movement in the S&P. It’s possible that that index won’t break decisively below the 1850 level. It’s also possible that the important index this time around is the NASDAQ, which has dropped from 4358 to fall below its early February low of 4000 in the middle of the trading day yesterday. It then rallied sharply, which is a good sign.

In fact, the similar action of the S&P yesterday was a lot better than the weak pattern it has been showing in recent weeks of early rally followed by late-day fade.

I’m not 100% convinced that we’ve seen near-term lows. Today will probably provide more evidence.

2. For some reason, stocks in downtrends most often “retrace,” as technicians put it, 1/3, 1/2 or 2/3 of their prior rise. I have no idea why. But there are plenty of previous high-fliers that have reached the first of these milestones. We have to ask, of course, whether we see any value in the security at this level, as well as whether the current level is as bad as it’s going to get.

March 27, 2014

It seems to me that the stock market has undergone a substantial change of mood over the past couple of weeks. Part of this is reflected in the move of the averages, part of it not.

First of all, the market seems to completely run out of energy when it approaches the all-time highs of early in the month. We seem at best to be bounded in a range that has 1878 on the S&P as a ceiling. The floor, at least so far, is around 1840–although the fact that we have tried to breach 1878 several times and failed suggests that we will soon see if 1840 is indeed a defensible level.

At the same time, there has been a remarkable rotation within the market–away from riskier stocks and toward more defensive ones. Among the markets former favorites–I’m thinking particularly of leaders in technological change and firms with large China exposure–recent declines have been sharp. Down 15% looks to me about the norm, with some high-fliers losing almost a third of their value.

Daily media commentators are attributing the current market churn to fears about Russia-Crimea-Ukraine as well as worries that China’s transition from exporter to domestic demand-driven economy will entail much more heartache than the consensus now expects. Although both issues may end up making market trouble, I don’t think either is what is driving stock prices. I believe this is all about the Fed.

Hedge fund manager Seth Klarman has described the current US stock market as being like a Rorshach inkblot–that is, an ambiguous mess onto which investors are projecting their own personalities in an attempt to find meaning. I don’t believe this either. I think we’re undergoing a large number of structural changes, each of which may be tugging stocks in one direction or another. Patient analytical unravelling, not therapy, will be the key to success this year. Underline the patience.

As I’ve written earlier in the week, I see current market movements as very encouraging. They are lessening the possibility that turmoil in the bond market will lead to equal negative action in stocks.

While I consider that the best course of action is to rotate into more staid names, I can’t help but be struck by the damage that has been done to, say, TSLA, which has lost around a quarter of its value in less than a month. I have no desire to buy now, but a couple of more weeks like this will probably change my mind. Purely a tactical consideration, but still potentially a profitable one (but not today).

March 12, 2014

caught in powerful crosscurrents

The S&P 500 has been meandering without any clear direction for the past couple of weeks, although still managing to keep above last year’s record high of 1848. Although having the S&P (or any other major index) go sideways for any length of time is most unusual, I suspect we may have to get used to it.

To my mind, the “natural” direction for the S&P to go in at the moment is down. Stock prices seem to me to be saying that upward momentum is slowing (look at the post below this one).

How so?

–the S&P is up by 20% over the past year, with little in the way of giveback

–if we take a chart of the index, connect all the short-term highs into a line and do the same with the near-term lows, we get a a corridor, or channel, that the index bounces around in as it heads upward (the long-term direction of the S&P, in my view). We’re now at the top of the channel. The next “bounce” should be toward the bottom.

–margin debt, borrowed money used to buy stocks, is at an all-time high. True, this is a flawed indicator in the US. But around the world margin buyers are the ultimate “dumb money,” so their recent enthusiasm is worrying

–big brokers are shrinking their holdings of S&P ETFs.

–speculative “concept” stocks have been having a field day, something that often happens at near-term peaks.

On the other hand,

–if we sell stocks, what do we do with the money?

…bonds? The signals coming out of the Fed since Janet Yellen took over seem to me to be confirming that the agency has begun to reverse the emergency monetary stimulus of the last half-decade and that pretty much nothing is going to stop the process. We know what will happen to bond prices as a result–they’ll go down. The only open question is when investors will begin to discount this.

…emerging markets? Personally, I think China is fine, as long as you’re careful and buy HongKong-listed stocks. But Argentina, Turkey, Indonesia, Brazil…? Ugh.

–the longer we stay above 1848, the more powerful that level becomes as resistance to downward movement

backing and filling?

That’s what technicians call stocks just churning around after an advance, waiting for something new to happen. Maybe that’s what we’re in for over the next few months.

what difference does this make?

Taking a strategic view, not much. It seems to me that stocks remain the asset of choice for most investors. From a tactical perspective, selloffs–which typically hit market leaders the hardest and leave clunkers relatively unhurt–provide a great chance to upgrade portfolio holdings. No selloff means the work of offloading the latter and acquiring the former is harder. To my mind, this is currently all about shifting away from pent-up demand/business cycle consumer stocks (what a mouthful!) and toward creators of structural change.

February 25, 2014

a purely tactical issue

We’re at an interesting short-term juncture for the stock market. In early February (as the post below this one details) the S&P established a low at around 1740. That bottom forms the potential lower bound of a trading range for the stock market.

The S&P then moved rapidly back up to the prior closing (and all-time) high of 1848. Yesterday, the S&P breached that high during the day, but closed below it.

What happens next?

We can go in one of two directions:

–we can break through the prior high–and continue to move upward, or

–we can bump up against the former high before turning down–potentially to travel most/all of the way back to 1740.

I think it’s a tossup as to which way the S&P goes. But, if history proves to be a guide, it won’t just tread water, It will either go up or down.

what to do

First, I should make it clear that my view is that the longer-term direction of the market is up. Trading thus far in February is giving us an indication of which stocks and groups are going to lead this year’s advance. From observing recent stock movement, I’ve got a couple of clunkers that I should get rid of and reallocate the sale proceeds to better areas. As usual, I kind of knew about these stocks before, but the recent up move, in which they have not participated, has hardened my conviction.

As a result, I wouldn’t mind it so much if the current attempt to break through the former high fails and the market declines to test the low it made early this month. Presumably, my clunkers wouldn’t participate, so I’d be able to sell the duds at around today’s prices and buy stocks with better prospects at lower ones. If the names on my bad list began to match the market on the downside, I’d at least know that I’d better change my plan and jettison them immediately.

So if the current rally peters out, we have useful work we can do to strengthen the portfolio.

If, on the other hand, the S&P breaks through the old high, we should just sit back and enjoy the ride–monitoring for when the upward momentum begins to slow.

February 14, 2014

Happy Valentines Day!!

the charts

Although I think the fashion is dying out, market technicians always used to wear fringed buckskin jackets. I don’t have one, but metaphorically donning it,

–on February 3rd, the S&P 500 hit an intraday low of 1741 at the close. Two days later, on the 5th, the index touched 1740 early in the day–and has been recovering since.

My working hypothesis is that that event marked the end of the correction that led off the year. It lasted a month; the S&P fell 6%.

Two things are important about this conclusion:

–if I’m correct, the 1848 high and the 1740 low define a channel the S&P will operate inside of for a while. It will be hard for the market to break through either to the upside or the downside. The longer we stay in this range, the harder it will be to move out of it.

The overall outlook for better growth in world economies this year than last suggests that the eventual breakout will be to the upside. In the meantime, the channel gives us a guide for trading. The closer the index is to 1740, the more eager we should be to buy; the closer we are to 1850, the more willing we should be to sit on our hands–or maybe take some profits.

–the end of a correction is many times like reaching the end of an old story and turning the opening pages of a new one. We should pay careful attention to which stocks are doing well and which ones are doing badly as the market starts back up. Often, relative performance in period like this will give a good early indication of new themes the market may be embracing.

As always, the winning combination would be a stock that fell less than the market on the way down and which is also outperforming on the way back up. The toxic mix–and a strong sign to ask why we continue to hold a stock like this–is the name that underperforms both during the down phase and during the recovery.

my observations

What really strikes me is how strong stocks that have a cloud presence and/or products that appeal to Millennials have been.

A cautionary note: We’ve had two weak government Employment Situation reports in a row. Retailers are signalling that January wasn’t such a great month. The consensus view is that this is not just due to the epic amount of snow we’ve had in many highly-populated areas of the US, but rather it indicates the overall economy has shifted into a somewhat slower gear. I find this last hard to believe, since pre-snow most indicators were signalling acceleration, not deceleration. We may not know for sure until March.

This worry may be one (the?) reason equity money is flowing into social media, Millennial and cloud names, where the attraction is more the promise of secular change rather than near-term earning power. Something to be alert about.

I’ve been finding my own portfolio moving toward having a larger (but still small, in the overall scheme of things) percentage in potential secular winners and toward having a somewhat more defensive cast in the rest.

More generally, though, I’m reluctant to make any dramatic changes to my portfolio structure without more data. So I’m spending most of my time trying to find and eliminate the clunkers that haunt the dark corners of everyone’s portfolio (even yours, although no one ever wants to believe this).

January 24, 2014

If you compare dates with the post below this one, you’ll see it’s been a pretty long time between CMTs. That’s partly because I’m naturally lazy, partly because there hasn’t been anything earthshaking to write about. There are only so many ways one can say just hold on and enjoy the ride. I’ve also made comments on Keeping Score that would otherwise go on this page.

What’s changed?

1. We’re in a new year, for one thing. Professionals, who are almost always paid for calendar-year performance, are through with nursing their gains into the holiday season. The slate has now been wiped clean. Pros are being forced to think more carefully about what they’ll do to earn bonuses in 2014. Remember, bonuses typically make up the vast majority of portfolio managers’ compensation so resetting the portfolio is serious business.

2. The S&P gained 11%–in pretty much straight-line fashion–between the second week in October and yearend. The S&P started to flatten out as we entered January. After revisiting the 2013 high of 1848 on the 15th, the S&P appears to have decided that 1850 is important resistance and wants to retreat for a while.

3. The consensus view, which I think is more or less correct (itself a worrisome thing), is that 2014 will be a consolidation year, where the S&P rises mildly while digesting the huge gains put up in 2013. The prevailing view is that total returns from owning the index will likely fall in the +5% – +10% range. Not bad, considering the returns from cash will be effectively zero and bonds will probably generate losses. But not the continuous gains of 2013 just from owning the asset class, either.

In a range-bound situation like this, short-term traders will first try to define the top of the range. That may be 1850. Once they’re convinced they’ve found where the top is, they begin to sell. That’s so they can see where the bottom of the range is. To me, the chart of the S&P 500 says the first possibility for the lower end is 1750, the next 1700.

There’s a good chance that this probing process–a normal part of life in a sideways market–is now under way.

what to do

After the large gains the stock market experienced last year, some giveback is normal. To my mind, the only real concern would be if the steep falloff in employment gains portrayed in December Employment Situation report is not the statistical accident I take it to be. We’ll get more data of the first Friday of February. Other economic data are so overwhelmingly positive, I’m operating on the assumption that the December ES is a fluke.

Unless you’re going to remain glued to a screen all day and make short-term trading a career, I don’t think there’s any way to beat professional traders at their own game. Our advantage is in taking a longer-term view.

There are, however, two useful things that each of us can do when the market is going down:

1. Try to “read” the market, by looking for patterns in buying and selling.

What kinds of stock are relatively strong on up days and on down days? Which are relatively weak on up and down days? These can be important signals that the market is trying to establish new leadership, or discard the themes that drove performance in the recent past. Do these patterns confirm or contradict your views on how 2014 will play out? In my experience, it’s especially important to look carefully at any chronically weak issues that show up in your portfolio.

2. A lot of times, short-term selling makes little long-term sense.

Stocks may be sold simply because they’ve been strong performers in recent months. Others aren’t hard hit solely because they’ve been dogs in 2013 and just haven’t gone up. A correction provides a great chance for us, as long-term investors, to do some portfolio housecleaning and upgrading buy selling dogs and buying winners at relatively favorable prices.

October 9, 2013

My equity portfolio showed the first real signs of unraveling yesterday. “Unraveling” is perhaps too strong a word. But yesterday was the first day since the question of possible government default on Treasuries came on the table that my holdings have underperformed the market.

Why should I be looking so closely? Regular readers will probably know that I think it’s a bad idea to get too wrapped up in day-to-day stock moves. Yes, I believe that with enough observation, and maybe some training, you can get to the point where stocks “speak” to you by the way they trade. But you also run the risk of becoming obsessed by the short term–and thereby being shaken out of good holdings through fear induced by random stock price movements. I also think that you and I have absolutely no advantage over professional short-term traders. We’ve got to rely on our brains rather than our speed and take a (much) longer time horizon than they do.

So why am I looking day-to-day now?

First, I’ve given up caffeine, so I’m not as twitchy as normal.

I no longer make my living by delivering steady outperformance, so I’m not as pressured as I was when I was working for others.

Probably most important, I think that at potential inflection points in the market–which I think the government shutdown/debt ceiling situation might be, you can get early warning signals of a change in direction by watching your portfolio extra carefully. Of course, this only works if you hold individual stocks. And you can’t let stock price declines scare you. You have to just observe and analyze.

What did I see yesterday?

–only one of my 14 stocks (CASY) went up. On prior down days, at least several were in the green

–a number of my holdings were down sharply. SPLK, for example, was off by more than 5%

–recent outperformers were hit very hard

–my one remaining Hong Kong stock, Galaxy Entertainment, has begun to wobble (until now, Hong Kong, which is typically very sensitive to macro concerns, has been a tower of strength until now)

I didn’t see any sector or thematic pattern to the selling. It was just that recent outperformers were subject to pretty aggressive profit-taking.

What to make of this?

I think that for the first time the complacent Wall Street view that the current crisis in Washington will end with the usual last-minute rescue is being called into question.

I continue to think that there will be come eleventh-hour compromise that will avert debt default, not because I have any great confidence in Washington, but because the alternative is potentially so destructive. I know we’re not talking Cuba or Argentina, but the very least even a quickly cured default would raise the Treasury’s borrowing costs.

From a tactical point of view, the safe choice is to ride the situation out, monitoring for possible changes in the market’s sectoral preferences as we do so. The riskier tack would be to buy into any weakness that might occur between now and the 17th. My daily portfolio watching suggests to me that if there is to be any short-term selloff, it’s beginning now.

From a strategic point of view, I think any long-lasting economic damage is being done now. It will be especially important to watch how China acts over the coming months. Beijing has already gotten the message that Washington will not allow it to spend much of its $1.3 trillion in Treasuries buying assets in the US. The real question, I think, is how aggressively China acts in trying to run down its Treasury holdings. Remember, a decade ago, when China was accumulating its large position, economists speculated that its buying activity lowered US long-term interest rates by about 100 basis points from where they would have otherwise been. The road back to “normal” rates would be much steeper without China.

July 16, 2013

another record high for the S&P!

…Where to from here?

Just about a month ago, a mini-panic broke out among bond investors, who were reacting to continuing hints from the Fed that the US economy is past the worst. Although the patient would still be staying in intensive care, the doctors were suggesting they’d cut down on the dosage of emergency money therapy being pumped into its system.

bonds vs. stocks

Long-term Treasury bond yields, which had been drifting upward since the beginning of the year, spiked by 30bp or so in a week. In sympathy, the stock market dropped by 5%.

Then senior Fed officials began a large-scale publicity campaign aimed at calming the financial markets down. For me, the most notable quote came from Dallas Fed president Richard Fisher, who likened short-term traders to the infestation of “feral hogs” that plagues the Lone Star State, and which wreaks mindless, pointless destruction on the countryside. Ardent reality TV watchers know all about this.

The jawboning campaign quelled the panic. The S&P, which had already been slipping from its May high of 1669 and had dropped from 1650 to 1578 in four trading days, is now in new all-time record territory at 1682.

Interestingly, Treasury bonds have made back none of their losses. The 10-year bond was yielding 2.60% as the stock market was bottoming. It’s at 2.57% now. The 30-year yields 3.61% vs. 3.60 on June 25th.

So far, so good for the theory that the stock market will follow its traditional pattern of going sideways to up while emergency money support is withdrawn from the economy. It seems to me that the next potential stumbling block for bonds (and, therefore, stocks) is when the Fed signals it’s about to raise the overnight Fed Funds rate from the current 0%. But that’s probably a year or more away.

chart gazing…

…won’t get us much information. There’s nothing but blue sky above on the chart of the S&P 500. We do know, however, that the index bounced pretty sharply upward from 1578. That figure falls at (or very near) the bottom of a channel the S&P seems to have been in since December–meaning 1580-1600 may turn out to be a significant area of technical support.

an optimistic thought

Although I would be perfectly happy with sideways to up for the stock market over the coming months, there is an argument that performance could be better than that. It’s not one I’d be willing to put money on, however.

It’s that the stock market has been marked by extreme risk aversion since 2008-09. Over the past three quarters a bit of that has begun to normalize itself. The 20%+ rally we’ve had since last December hasn’t been driven by surprisingly good earnings. Half of the advance has been due to price earnings multiple expansion.

To my mind, the market is still exhibiting a recession-induced reluctance to discount earnings prospects more than a month or two in advance. A normal market would be beginning to factor into today’s prices expectations for 2014 earnings–which are almost uniformly good. Were investors to come further out of their defensive shells by starting to looking ahead to 2014 instead of waiting for future earnings to happen, that could easily add 5%-10% to the level of the market.

I prefer to think of this possibility as a cushion against future bond-caused bumps in the equity road than as a reason to think the index has lots of overhead room from here.

May 30, 2013

It now seems to me that we’re either at, or very near, an important market inflection point.

Current market volatility is saying to me that securities markets in the US are beginning to exhibit symptoms of a tug of war between two opposing forces. This is not a battle that will be over in a day, but instead will likely continue for many months, if not longer. The forces are:

2. an imminent move by the Fed to raise interest rates back to normal from the current ultra-emergency low, pushing both stocks and bonds lower.

Actually, what I’ve just written isn’t the entire story.

I think Wall Street has decided that both developments are close enough in time (even if we don’t know exactly when) and that stocks and bonds are priced such that there’s no longer any money to be made from betting that rates will stay low or that earnings won’t expand. Therefore, the odds strongly favor portfolio repositioning.

history as a guide

History tells us a lot about such transition periods:

–interest rates will move up steadily and by a lot–at least by 200 basis points

–this is unambiguously bad for bonds

–stocks move sideways to up, as the upward pressure from rising corporate earnings offsets most/all of the downward pressure from rising rates.

different this time?

In a way, however, we’re also in uncharted waters, because:

–the Fed has already told us that the normal level of overnight money is around 400 bp higher than the current zero. There hasn’t been a rise this large since the early Volcker days, 30+ years ago.

–individual investors in the US today are generally older and more income oriented. It’s unclear that they’ll have the same strong appetite for equities they’ve had in the past.

my bottom line

My guess is that the process of raising rates will be a long, slow grind upward that could take two years–although once Wall Street catches on, it will act to reprice securities more quickly.

From a stock market point of view, I’m sticking for now with the idea that the two forces–earnings and rates–will offset one another. However, within the market:

–stocks with the strongest eps growth–that is, those more sensitive to the business cycle–will fare the best

–defensive bond proxies, which have been the beneficiaries of investors searching for income, will suffer from their bond-like nature, and will lag the averages

–at the same time, I think basic industrial materials stocks won’t star either. Two reasons: a) capacity increases from the past decade of high prices mean supplies will be more ample, and b) a shift in China to less commodity-intensive growth will take the edge off demand.

April 25, 2013

flow changing? …maybe not

Well, either the storm clouds I perceived as potentially rolling in to rain on the Wall Street parade were a total figment of my imagination, or they dissipated almost immediately without doing much damage.

The S&P hit a low of 1536 intraday on April 18th, the day after I wrote my previous installment of this page. But since then the S&P has been motoring higher. So technical alarm bells are no longer ringing in my head. The only consequence I can see of the market dip is that it strengthens the area around 1550 as significant resistance (for what it may be worth, the next stopping point I see moving south is around 1500).

On the other hand, given the strong positive performance of the index since November plus what I regard as generally so-so 1Q13 earnings reports being delivered by S&P constituents so far, I find it hard to imagine that the index will keep barreling ahead. Instead, I think a lot of the market’s positive energy may be focused on rotating from leading industry groups to laggards.

rotation, not pure rise

There are several reasons why rotation would happen:

–it’s what the market always does. As some groups rise sharply, short-term traders will perceive valuation differences between the winners and laggards that they regard as excessive. So they’ll arbitrage the difference by selling the winners and buying the laggards. This causes the former to stall and the latter to rise.

–although not all the results are in, my impression is that so far the earnings disappointments have been centered in the defensive groups that have been market stars so far this year.

–a number of economically-sensitive companies that have reported lackluster results and indifferent guidance have gone up on this news–among stocks I own, CAT and INTC come to mind. In contrast, defensive stocks doing the same thing have tended to drop sharply.

Assuming I’m reading the market correctly, I don’t think this movement is based on–or is signalling–an acceleration in general economic activity. I think it’s based primarily on valuation. My sense is that the market is saying that, for instance, CAT may not get much cheaper than it is today and that the rewards for holding the stock when business picks up in six months or a year will be big enough to justify buying it now.

Another way of saying the same thing is that the defensive areas have been all picked over and that bargains will mostly be found in out-of-favor areas. This is a basic value investor tactic.

April 17, 2013

is “the flow” changing”? …maybe

To be clear, the positive one-year, two-year, three-year…case for stocks hasn’t changed. But the short-term trading action of the US stock market over the past two days–and in today’s pre-market activity–is substantially different from what it has been since last November. …enough so, I think, that we should adopt a less aggressive attitude toward portfolio structure for the moment, while watching to see if a new pattern persists.

Until this week, stocks have seemed to me to have wanted to go up, in a way not completely justified by the level of earnings growth I’ve been expecting. Evidence:

–There have been lots of up days.

–Many days when Wall Street has sagged in the morning, an afternoon rally has emerged from nowhere to bring the averages back to around breakeven.

–If you do the connect-the-dots technical work, you can see that the line connecting short-term highs in the S&P 500 and the line connecting the short-term lows form a well-behaved upward trending channel.

Or at least they did until Monday.

Now a chart of market action over the past month looks more flattish, with stocks trying to achieve escape velocity to rise above 1550 on the S&P 500–and being unable to do so.

In addition, the sawtooth pattern of the past three days–big down, big up, (pre-market) big down–is not only different from previous market action. It’s also characteristic of a market where bullish and bearish forces are roughly equally balanced and struggling with each other over what direction stocks will take next.

It’s unclear whether what I’m seeing is just turbulence that will soon go away, or whether the sawtooth pattern presages a downward move in the S&P to, say, 1500. But I think the chances of the market going up from here in the next short while have diminished.

What to do?

If you have a long-term perspective, nothing.

If you have a tactical perspective, it may be time to trim positions that have done well so far this year and that have become larger than you might like. It may also be time to wait on the sidelines for possible lower prices before buying more.

I think everyone should do is to look at how their positions have fared over Monday and Tuesday. Look in particular for stocks that have either outperformed the index on both days or underperformed on both days. Any in the latter category should be examined carefully to make sure the positive case is still intact–because the market is telling you it isn’t.

Remember, too, that a market correction (if that’s what we’re seeing advance warning of) is always an opportunity to upgrade a portfolio. Doggy stocks–ones that haven’t gone up over the past half year–may not go down much in a correction. A downtrending market provides a good psychological excuse–and a better financial opportunity–to trade them in for something more useful.

We’ll know more in a few days.

April 11, 2013

going with the flow

At yesterday’s close the S&P 500 is 2.3% higher than it was the last time I added to the Current Market Tactics page.

The index has achieved a new all-time high, too. It’s also that much farther above the target I set only last December for where the index would finish 2013. Nevertheless, I feel that the market still wants to go up.

Two changes, though, over the past several weeks:

–the tone of market commentators has become much less bearish (a mildly worrying development), and

If we accept the current level of the market at face value, two possibilities occur to me:

–the S&P’s behavior looks to me like a slow-motion or lower-energy version of what the market typically does as an economic rebound begins to take shape after a government-induced inventory-cycle slowdown. …in other words, what happens after a garden-variety recession, once the market decides that the worst is behind us.

If so, considerable further market upside is likely.

I ruled this possibility out completely a few months ago. I mention it now just because it’s what stock prices seem to be saying. I don’t think this outcome is likely and I’m not going to alter my portfolio in anticipation of it. But I feel I can no longer reject it out of hand–meaning I’m going to be a little slower to make my holdings more defensive.

–maybe conservative investors are beginning to prepare for the eventual rise in interest rates that will take the joy out of holding bonds. This would be what some are calling the “Great Rotation.” So far there is some evidence that investors are shifting cash balances into stocks, but none that money is shifting out of bonds. It could be that the Great Rotation will never occur, or that we’re in the very early stages. In any event, I don’t see the GR as a plausible reason for stocks’ buoyancy.

One caveat: there are reports that traditionally bond-oriented hedge fund managers are shifting into stocks in a big way, and that some bond mutual funds are using leeway provided in their prospectuses to do the same thing on a more modest scale. But I’m not sure such purchases are large enough to move the S&P.

should we believe the S&P?

There is, of course, a danger in taking what stock prices are currently saying as gospel. After all, in mid-2007 prices seemed to be saying everything was rosy; in March 2009, they seemed to be telling us to run for the hills.

My bottom line: I’ve got to keep in mind the possibility that the post-recession world economic healing process may be more advanced than I perceive–and hence that this year’s corporate profit growth may be considerably higher, as well. But although I’m looking harder for evidence, I’m not changing my portfolio for now. I’m just going with the flow.

March 19, 2013

I still think today what I wrote in the post below on January 28th that the stock market in the US is in the grip of two opposing forces.

On the one hand, I can’t see aggregate earnings growth for the S&P 500 being much north of 8% this year. It’s more likely, in my view, to be +10% rather than +5% …but it’s not going to be +15%. Unless we’re willing to bet that price earnings multiples will expand, which is a much more subjective judgment–and subject to much more possible error, the rate of earnings growth sets a cap on possible near-term stock market gains. And the S&P 500 has already gained about 9% so far this year. So upside should be limited. And the market should be ripe for a correction.

On the other hand, Wall Street is showing considerable upward momentum. Stocks seem to want to go up. Why? It may partly be that retail investors who liquidated their stock portfolios in 2008-09 are beginning to put money back into the S&P. The bottoming of house prices, the primary source of wealth for most Americans, is certainly boosting confidence. The sequester is forcing Washington to come to grips with excessive government spending, which is a good thing. And S&P points out that bull markets that reach the five-year mark, which this one has, tend to have an unusually strong year five.

Right now, however, it strikes me that the S&P is beginning to flatten out after its big 1Q13 run and may go sideways for a while. I don’t think this is an issue of investors’ beginning to worry about the market’s fundamental underpinnings. I think it’s solely a reaction to the speed at which stocks have risen, year-to-date.

During periods like this, investors tend to spend their time trying to upgrade their portfolios through sector, industry and individual stock selection. A rotation away from defensive industries and toward more pro-cyclical ones appears to me to already be under way. Although the Consumer Discretionary sector has already done well, I think stocks that cater to average Americans still have considerable potential. I also find it interesting that Europe-based multinationals are outperforming pretty steadily, no matter whether day-to-day news appears to benefit or hurt their earnings prospects.

How long will the market move sideways, if my instinct is correct? I have no idea. In a “normal” year, investors would begin in June or July to begin to factor into current prices their first thoughts about the following year’s possible earnings performance. But that’s an awfully long time for the stock market to do nothing. More likely, the market will shift out of neutral as 1Q13 earnings begin to be reported next month.

For now, I see no reason to become defensive. I think that any correction that may come our way will be shallow. A 3%-5% decline, if it happens, may well be the catalyst for renewed buying.

January 28, 2013

It’s been quite while since I’ve updated Current Market Tactics, although I’ve written a lot of what I think is useful stuff on strategy for 2013.

Well, it’s less than a month into the new year and the S&P 500 is already up by 5.4% on a capital changes basis. That’s the lion’s share of the 8% or so I though would be justified by likely earnings growth this year. This is an issue. If I’m correct, someone buying the index today does so with the expectation of a return of around 4% (2% capital appreciation + 2% dividend yield) over the next 11 months. Is this enough to justify buying? …normally, no.

On the other hand, looking at daily price action, stocks seem to me to really want to go up–even from here. I think this is partly due to the less insane-sounding noises coming from Washington these days, partly to the apparent rekindled desire by private investors to own stocks–after having watched them going up from the sidelines for almost four years. In other words, the market’s price earnings multiple may be in the process of expanding.

This is not the surest footing in the world, at least over longer periods of time. The behavior of individual investors is arguably a contrary indicator. And Washington has acted in an unusually investor-hostile way during the past two administrations. Nevertheless, I find myself wanting to become a bit more aggressive.

Where I’m looking:

1. I’ve been writing for several years about the atypical two-stage economic recovery now happening in the US. During Stage One, which covered 2009-11, the place to be was in the parts of the economy that cater to the affluent–the top 20% of wage earners who do 40%-50% of all consumption. Last year, we entered Stage Two, where housing has started to turn up and the investment spotlight began to widen to shine on the other 80%. Over the past few months, the secular growth, semi-luxury winners of 2009-11 have been falling further behind, it seems to me. Construction, furniture, home improvement are where I’m doing research now. I’ve never been a big fan of homebuilders (to my detriment in 2012), but–for what it’s worth–they appear extremely pricey to me.

2. Unlike last year, when it was best to own stocks whose earning power was concentrated in the US, construction with Asian and Latin American exposure (I own CAT) seems to me to have some merit.

3. I’ve begun to look at beverages companies–not KO or PEP, but companies like DIA. A rising €, emerging markets exposure and appeal of products to ordinary Americans seem to all be acting in their favor. I haven’t bought anything yet, though.

4. I also find myself with a rising cash position–an oddity for me–as I trim large positions or sell stocks I think have done all the work they’re capable of. Late last week, for instance, I sold the DIS I bought a few months ago when the stock declined on a disappointing quarterly earnings report. I like the company but I think the multiple was too high. I have incipient worries about ESPN, DIS’s largest business, but I’d buy the stock back at a lower price.

I’m using two tried-and-true ways of parking the money while I look–index ETFs and utility stocks.

5. I’m also thinking of buying more of the Mathews China-related funds I own, because the PRC is clearly shifting into a higher gear, but haven’t done anything yet.

November 15, 2012

A very recent poll by the Pew Research Center indicates that most Americans don’t understand what the “fiscal cliff” is. But they’re convinced it’s bad and it will hurt both the economy in general and themselves in particular if we drive over it.

Chastened by their loss to a man unable to pass Economics 101, Republicans appear surprisingly willing to compromise. In his public statements so far, President Obama does not. This gridlock dynamic has investors nervous. There’s some basis for this unease, since the same Pew poll indicates Americans by almost a 2:1 margin will blame the Republicans if talks fail. So Mr. Obama may have little incentive to negotiate. In addition, we know from experience that the President doesn’t play well with others and generally can’t abide people who disagree with him.

But I don’t think that’s the major reason stocks have been selling off since the election. After all, this is the status quo ante. And exit polling seems to show that a large majority of voters regarded the Republican stance on basic human rights–treatment of illegal aliens, abortion, gay marriage–to be unacceptable.

As I’ve suggested in a prior post, I think the decline is all about the prospect of higher taxes on capital gains and dividend income–which are on the way no matter what deal is struck on the fiscal cliff. How much higher these taxes will be next year may be open to question, but the fact of significantly higher rates seems to be beyond doubt.

The relevant questions for us as investors are:

–how long will the selling go on?

–how bad will it get?

–what types of stocks are most likely to be hit?

The first question is easy. (Let’s assume no unusual developments in the fiscal cliff negotiations–the consensus belief being that the Federal tax on long-term capital gains will rise from the current 15% to 20%-25% in January, and that on dividends will go from 15% to 40%-45%.)

Investors tend to close up shop for the year around mid December. Institutions close their books. Volumes dry up. Everyone celebrates the holidays. So potential selling has about a month to go.

What kind of stocks? …big, long-term winners like AAPL, where capital gains are big. Two wrinkles to year-end planning: losers will likely be sold off in January, when capital losses will be more valuable; and the “January effect” for 2013 may consist of a sharp rally in sold-off long-term winners (so think about taking a few minutes off from the holidays to go bargain hunting in late December).

Extent of the selloff? Let’s look at the charts. It seems to me there’s strong resistance for the S&P 500 at around 1350, which would represent an 8% decline from the recent highs. It’s also about where we are now. The next line of defense is around 1280-1300. My hunch is we’ll flirt with 1300 before this is over–but I would bet zero on that idea.

My bottom line(s):

–wait to buy

–use the tax change only as a factor that tips the balance in favor of selling a stock you’re on the fence about. Don’t sell purely for tax reasons.

October 24, 2012

the 3Q12 earnings season

During the current 3Q12 earnings reporting period, companies whose results have come in below the Wall Street consensus estimates have suffered very sharp price reversals. The latest casualties have been the big global chemicals companies. Note Dupont (DD), which fell 9% yesterday.

My first (and incorrect, I now think) reaction to this behavior is that it’s very odd–and unusually negative. Why? …because world stock indices, including the S&P 500, have spent the past few months discounting an upturn in overall economic performance, based on three macroeconomic developments:

1. signs that EU political leaders have committed themselves to saving the Eurozone rather than letting it dissolve. There may well be collateral damage, if the UK opts out and/or Greece is tossed out. But the general macro trend has turned much more positive (okay, maybe much less negative–but for investors who had been fearing the worst, that’s good enough).

2. indications that the Chinese economy is bottoming. This is partly due to stimulative measures Beijing is already taking, partly to the fact that the once-a-decade leadership transition in that country’s Communist Party is just about complete–meaning more stimulus is likely on the way.

3. revival of the US housing market after five years of decline.

I’ve been regarding all this as, in effect, the beginning of a new business cycle. And it is–except for the US.

When equity markets begin to discount an upward turn in the business cycle, stocks typically rise across the board, almost no matter what their near-term prospects are. There are two reasons this happens: the expectation that profits will be sharply higher, sooner or later; and bargain basement current valuations.

For the US , the current situation is somewhat different:

–there has been no change in overall domestic government policy. Rather, we are enjoying the positive rub-off effect of policy changes in the EU and China. In fact, there’s some chance fiscal policy in the US will take a sharp contractionary turn next year (the “fiscal cliff”).

–the severe decline in the price of houses (by far the largest source of wealth for most Americans) over the past half-decade has caused recovery in the US to be a two-tiered affair. Housing and consumer spending by all but the wealthy have lagged the rest of the economy about three years and are only beginning to recover now.

–three years + from the market bottom, prices are no longer cheap.

So although this looks and feels somewhat like a cyclical market upturn in the US–and for housing, entertainment, leisure, travel…it is, for many others–especially commodity/industrial–it really isn’t.

What’s happening in chemicals is more like end-of-cycle stuff. Demand is weakening, and operating leverage is turning small sales declines into sharp profit drops. Investors and analysts, conditioned to hearing good news, are being taken completely by surprise.

investment significance

The most important question for us is whether we think these sectoral problems spread and infect the rest of the market or whether they remain contained. Based on supportive money policy at home and favorable economic developments in the EU and China, I remain in the “contained” camp. But this is a conclusion that warrants constant monitoring.

October 12, 2012

From early June through mid-September, the S&P 500 gained almost 15%. During that time, the market was in almost constant upward motion–achieving higher highs and higher lows.

Since then the S&P has given back about 2%. Over the past couple of weeks, however, the market has begun to show a decidedly more defensive bent. Utilities and Healthcare are outperforming, and IT and Consumer Discretionary are lagging. At the same time, current economic news coming from the EU and China is less positive than anticipated. This is presumably the cause of the market’s lack of direction.

Not only that, but we seem to be in an inventory correction that is hurting manufacturers. The process is as follows:

Retailers discover that sales are running, say, 5% below plan. As a result, they have 5% more merchandise on their shelves than they think they’ll need. The way they fix the problem is to cut down the amount of new merchandise coming to them from their suppliers. So they cancel or reduce some orders. By how much? That varies by how fast the retailer turns over its inventories. A reasonable estimate is that the retailer needs to cut back its reorders by 20% for the next six weeks. Just to be on the safe side, it probably either cuts back by 25% or for the next two months–or both.

The important point is that as business slows versus expectations, as is apparently happening in the EU and in eastern China, retailers reduce orders by a much larger percentage than the sales slowdown would appear to warrant.

That’s why, in my opinion, the sectoral rotation away from manufacturers has been much more powerful than the overall market decline.

Is this a cause for concern? 2% isn’t. We can easily read the drop from the September highs as a natural countermovement, or “backing and filling,” after a large multi-month market advance.

But “inventory correction” is also the standard description for the garden-variety recession that appears in the US economy every half-decade or so–and depresses the stock market for at least six months when it arrives.

Is that what’s happening now?

My guess is no, but I think we’ve got to keep a close eye on the situation. While I have no desire to sell names like INTC that have been hit hard recently, I also have no urge to add to my positions.

My guess is based on two positive factors:

–garden-variety recessions have typically been caused by governments raising interest rates to try to cool down overheating economies. Rates worldwide are either already close to zero or headed down.

–the Great Recession was so recent and so painful that excess inventory buildup is likely relatively modest. If so, the inventory adjustment should be over by January.

During most of my time in the stock market, I’d also be inclined to point out that S&P movements themselves are the best leading economic indicators we have. A 15% market gain should mean that corporate earnings will be growing strongly six months from now. While that may still be the case, the gradual change in the character of market participants over the past decade from investors anticipating the future to traders reacting to short-term news flow makes me less willing to bet the farm that this is still so.

My bottom line: not a time to be more aggressive, possibly one to become a bit more defensive.

September 26, 2012

first thoughts on 2013

further PE multiple expansion possible

If we look at 2012 to date, the estimates analysts made this time a year ago of likely earnings for the S&P 500 haven’t changed that much. In very simple terms, then, the rise in the S&P over the past year can be attributed to two more-or-less equal parts:

–the shift by investors from valuing the market based on 2011 earnings to 2012 profits, and

–expansion of the market price earnings multiple from 13x to 14x.

Multiple expansion itself can be attributed to two causes: increasing confidence that expected earnings will be achieved; and the continuing decline in interest rates, which has raised the price of bonds (the only liquid substitute for stocks), pulling equities upward in its wake.

Using traditional methods of comparing bonds and stocks–the coupon on long Treasuries vs. the earnings yield (1 ÷ pe ratio), stocks at 14x eps would imply an equivalent long bond yield of 7.1%.

Meaning…? …that stock valuations already have baked into them a rise of 400 basis points in the 30-year bond. In other words, stocks remain cheap vs. bonds. More important, another, say, 1 percentage point rise in the market PE multiple during 2013 is possible.

I don’t think we can pencil multiple expansion in as a certainty, but I think there’s at least a 50% chance of it occurring. And I think the risks are asymmetrical (as they say), meaning the chances of PE contraction are very small.

earnings growth next year?

Therefore, if S&P earnings were to grow by 5% year-over-year in 2013, a reasonable expectation would be for a 10% rise in the index.

Is it reasonable that earnings will rise in 2013?

In crude terms, 50% of the S&P 500 index earnings come from the US, 25% from Europe and the rest from the Pacific and Latin America (except for Japan, mostly emerging markets).

Let’s start with Europe.

My sound bite description of Europe is that it is a replay of Japan in the 1990s, but with some hope of a better outcome. Just like in Japan in the early 1990s, we’ve already had the first dramatic economic/stock market decline in Europe. The recent significant positive change in ECB policy, however, suggests that we’ll have a period of stabilization next year and maybe even a mild boost in economic activity as looser money has an effect.

Let’s put down 3% eps growth for Europe-sourced earnings in the S&P–through some combination of currency gains and euro-based earnings progress. (As usually happens, the higher the euro goes, the lower local-currency earnings gains will be, and vice versa.)

Pacific + Latin America? Completion of the once in a decade leadership change in China’s Communist Party will doubtless end the current period of government inaction and produce more aggressive measures to boost economic growth there. That should have positive effects on the rest of the emerging world. Let’s make up a number and pencil in 5% earnings growth–a number that is surely too low.

The US. This is the toughest call. It’s also the largest chunk of index earnings. A second year of economic growth plus the recent strengthening of the housing market (the greatest source of wealth for most Americans) are generating rising overall consumer confidence. This means, I think, that consumer spending will be driven by the middle class, as well as the wealthy, over the next year.

Assuming 2% real GDP growth + 2% inflation, there would be would at least 4% nominal GDP expansion in the US next year. That would translate into at least 5% profit gains for the domestic operations of publicly traded companies.

This is the biggest imponderable that I see. If the Bush-era income tax reductions expire at year end and the mandated cuts to the Federal budget kick in as well, the Fed estimates the consequent decrease in spending will clip about 4 percentage points from nominal GDP in 2013. That may not be the end of the world, but it would erase all the otherwise expected economic growth for the US next year.

More important, no one believes this will happen. In particular, I read current stock prices as saying investors aren’t discounting this possibility at all (arguably, however, the Fed’s recent decision to launch another round of quantitative easing shows its belief that the negative outcome must be taken seriously). The negative surprise of continuing dysfunction in Washington, even on this important issue, would likely be enough to induce a mild recession in the US.

That would erase almost half of the 4.5% earnings growth I’m guesstimating for the S&P in 2013. This would make a much more significant impact on sector and company selection than it would on the overall level of the S&P. But there’s no denying that it would also take a lot of the shine off the otherwise positive case for stocks next year. The market would be more dependent on developments in the EU and China, as well.

More to come on this topic as we get closer to the end of the year.

September 25, 2012

thinking about the fourth quarter…

I’ve been struck recently by the large number of professional equity investors I’ve been either reading or hearing about who are saying they are in the process of effectively closing up shop for this year.

Their rationale is four-fold:

–they’ve done relatively well vs. their target indices so far in 2012–well enough, they think, that their customers would be satisfied with the performance achieved to date

–the S&P 500 is at post-2007 highs, despite sluggish global economic growth (and up by almost 20% so far this year). This is much better than consensus expectations.

–the near-term crystal ball is unusually foggy, with the US presidential election, the fiscal cliff, Greece and the Eurozone, growth in China all hard to handicap.

what closing up shop means to a professional

It doesn’t mean raising cash. It means temporarily moving much closer to index weightings in sectors, industries and individual stocks. The idea is to set the portfolio up to achieve the index return during 4Q12. The manager will forgo any further gains vs. his benchmark in return for not losing the outperformance achieved to date.

Either in mid-December or early January, a point when the manager presumably thinks the outlook will be a bit clearer, he will reset active bets.

the S&P 500 is unusually resilient, suggesting it “wants” to go up

The index is up about 3.5% so far this month. More than that, the 1450 line on the S&P is looking more like a significant level of support–and one last seen in 2007.

This is mostly due, I think to the recent upward adjustment in the volume of quantitative easing around the world. But it’s also partly because stock mutual funds still have boatloads of tax losses left over from 2008-09, so they aren’t doing their usual September-October selling to adjust the size of their fiscal yearend distributions.

Current index strength is the main tactical argument I can see for a professional not to want to protect his year-to-date gains against a possibly unfriendly market in 2013.

…still we should be at least thinking about next year

It’s not that far away. More about this tomorrow.

September 14, 2012

seeing which way the wind is blowing

Yesterday, in a separate post I suggested that a fundamental shift in the direction and tone of world equity markets might be in progress. I pointed to relative currency movements as a signal of this that’s typically ignored by Americans. The move being suggested by currencies is strongly positive for the EU, based on ECB rescue plans for Spain and Italy, less so for the US.

the Fed announcement

Another important feature of yesterday’s market action was the announcement by the Open Market Committee of the Federal Reserve that it will start a third round of unconventional money stimulus, concentrating on buying mortgage bonds. Its intent is to cause house prices to rise faster and to increase employment. What’s striking about this statement is that the Fed set no limit on the purchases, indicating only that it would buy at the rate of $40 billion a month until economic conditions improve substantially.

For most Americans, the largest and most valuable asset they own is their home. Rising home prices should increase consumer confidence, which should, in turn, increase consumer spending. I take this as being the Fed’s primary purpose.

Secondarily, to the degree that rising house prices enable unemployed workers to sell their homes and relocate to accept jobs elsewhere, the move may also indirectly improve the unemployment rate.

The Fed also committed itself to keeping short-term interest rates at the current zero until at least the middle of 2015, or in effect for the next three years. That should certainly send a chill down the spines of money market fund managers, whose remaining customers must now be considering moving into riskier assets. Stock market, anyone?

my reading of stock market reaction

1. European stock markets continue to rebound. Unusually, and just as important, the € is up almost another 1% so far today. Strong currencies and strong bond markets often go together. Strong currency and strong stock markets typically don’t; strong currencies often push stocks down. So the EU equity move is especially powerful.

Strong currency also has implications for sectoral choice, suggesting that one move away from exporters and multinationals toward purely domestic firms.

2. The Hong Kong stock market was up almost 3% overnight. I interpret this as meaning investors are concluding that better economies in the US and EU are both good for China. Stocks that cater to affluent Chinese were particularly strong.

3. In the US yesterday, the S&P rose 1.63%. Of the ten sectors which comprise the index, Financials (+2.58%), Materials (+2.56%), Energy (+1.85%) and Staples (+1.73%) outperformed.

Why those sectors?

Financials–beneficiaries of low interest rates, large European exposure (i.e., gainers from € strength)

Materials, Energy–beneficiaries of strong economic growth

Staples–large European exposure, therefore gainers from the €.

3. With the exception of Hong Kong, the main stock movement has been in larger stocks. Small caps have been left behind. This suggests to me that the heavy lifting is being done by institutions, not individuals. A more tenuous conclusion is that they are putting back to work cash balances they had amassed in the expectation of a market downturn.

what to do

I’ve got three thoughts:

1. For the first time in almost a decade my own holdings are underperforming the S&P, year-to-date. An aggressive allocation to smaller tech stocks and to social networking in Japan have been my downfall. As a result, I’m more than usually aware of how well the S&P had done this year. Do you know the numbers?

Through yesterday, on a total return basis, the S&P is up by 17.9%!!!

Probably the most prudent thing most people can do is add to stock market exposure through index funds. Your own active performance will speak to you.

2. The most powerful “big picture” idea I can see at the moment is that stimulus in the US and EU will be good for China. The Macau casinos, western luxury goods makers selling into China or one of the (actively managed) Matthews China-related funds–I own three different ones–might be worth looking at.

3. If current currency movements are indicative, one should have domestic-oriented stocks in Europe. One should also be beginning to shift away from domestic stocks in the US, in favor of EU and China-related names.

August 22, 2012

In early April, the S&P 500 made a recovery high of 1422. The market subsequently sold off, on disappointing economic news, to a low of 1266 in June. The market then reversed course–the signal that an upturn was likely being the extreme negativity of the financial new media–and has been moving steadily upward since.

Yesterday, the S&P made another recovery high of 1426 early in the day, before retreating to close at around 1415.

What to make of this?

On the one hand:

–over the past few months it has become clear that the US housing market is finally beginning to recover, after five years of weakness

–confidence among the 85%-90% of the workforce that is employed is high that their jobs are secure

–workers may have already received their first compensation increases since the Great Recession. If not, they’re anticipating that salary boosts are in the offing. So they’re loosening their pursestrings a little. They’ve probably taken a vacation, not a staycation, this year. And they’re likely trading up a bit in their purchases. At least, that’s how I’m reading corporate earnings announcements in the consumer sector.

–EU leaders appear to be doing enough to stave off the immediate demise of the Eurozone. Rightly or wrongly, investors seem to be reclassifying the EU as a chronically ill, rather than terminally.

On the other:

–the US election and the looming “fiscal cliff” don’t yet seem to have become a subject of concern for the market, and

–the recent strength is coming in August. For reasons I’ve never understood, senior investment managers around the world seem to take this month off, leaving their portfolios in the care of subordinates who have little discretion to act independently. As a result, stocks seem to drift throughout the month–sometimes not establishing the direction they want to take for the last third of the year until after Labor Day. I find it odd that the S&P should make a new high during such a lazy period

–I also get no sense that market participants have yet started to shape their portfolios to benefit from expected developments during 2013, although in normal times portfolio managers begin to do so in June or July

What to do?

I continue to think the S&P faces strong resistance at 1420. I expect the market will wait for further developments on the US electoral and Eurozone fronts before trying to break through on the upside. At the same time, the improving US economy suggests to me that market dips that happen while we’re waiting will be relatively shallow.

Although I don’t think the S&P will be making dramatic moves, there may be considerable rotation within the market.

My guess is that, while they may have contingency plans in case of an EU meltdown, professional portfolio managers have structured their holdings on the idea that the EU is simply a place to avoid. I don’t think they’ve shaped their holdings in the rest of the world in anticipation of a severe negative economic shock emanating from Europe. I don’t expect much change here.

Personally, I expect 2013 to be a year of recovery in emerging economies. So I’m beginning to tilt my portfolio toward companies with emerging markets exposure. Im looking for signs that others are following suit.

As for the US, I think that, apart from whatever the election will bring, the S&P will be subject to two conflicting forces. Corporate profits will continue to grow. Structural change in IT and the internet will continue at a rapid pace. That’s a big positive. But overall economic growth will be slower for the US economy than for emerging nations. Therefore, while the correct strategy in 2012 has been to focus on purely domestic companies, next year it will be important to have Asian and Latin American (not European) exposure.

We should also be watching carefully how the markets react as newly-tanned managers return from the beach in a week or two.

August 8, 2012

a little like Groundhog Day?

Here we are in early August and we’re back where we were on the S&P 500 in April, right around post-2009 highs of 1400+. We’ve also repeated, in somewhat stunted form, the summer swoons of 2010 and 2011. But despite the market’s recent gains, in many ways the economic situation hasn’t improved that much.

Europe is still a mess. Emerging economies are still slowing. Recovery in the US is still slow. High unemployment remains chronic. Washington remains detached, content to curse the darkness–or, rather, the someone else they’re blaming for the lack of light.

…except…

Nevertheless, the S&P has been steadily moving upward through a series of higher highs and higher lows since early June. What’s more, the market seems to be sounding an increasingly bullish note.

Although I don’t think it’s time to be carried away with optimism, the summer has seen several positive developments:

–China appears to be becoming more aggressive in stimulating its economy, despite this being a year of leadership change, when the Party is usually reluctant to make any economic moves at all. The recent strong positive performance of Hong Kong property stocks suggests government action is having results. And look at TIF over the past while.

–the July employment report from the Labor Department suggests the US economy is still making steady, although slow, upward progress–not running out of steam, as the official job figures were suggesting during the spring. In addition, after five years of down, the housing market is now clearly showing some signs of life.

— the soap opera-like Euroland crisis isn’t necessarily getting better (can it really be that Greek politicians, who have implemented virtually no agreed-to economic reforms, are talking again about haggling for easier terms? Answer: yes). But country governments appear to be at least recognizing the gravity of the situation and to be preparing–in their usual slow-as-molasses way–to take some action. At least, the situation doesn’t appear to be getting worse.

Where to from here?

On the S&P 500, we’re within a percentage point or so of where the market has continually met strong resistance for the past two years. My guess is the 1420 will again prove too difficult to push through–particularly with the presidential election approaching and with only okay (but not great) earnings news. On the other hand, I have the sense from watching the daily market action that stocks want to continue to go up.

My conclusion is to keep a positive portfolio structure, but to look around for places to trim.

where to trim

I’m looking at my stocks from three perspectives. I think you should do the same. They are:

–performance relative to the market since the beginning of April. What stocks have survived the round trip from 1420 to 1280 and back in the best shape? which have done the worst?

In my case, the most wretched stocks have been a smattering of smaller, more speculative tech issues, plus WYNN and LVS, and anything I own in Hong Kong. In theory, these should all be sell candidates, because they’ve done poorly through the complete cycle of up and down. I’m leaving everything alone, though. (In the case of the tech stocks, the question for me is whether to keep or sell. I’ve been so wrong that I feel adding to them, on the argument that if I loved them at higher prices, I should really love them now, is out of the question.)

–what’s worked since the beginning of the upturn in early June. For me, just about everything, ex one tech stock. That’s not a surprise, since I have an up market-oriented portfolio. Of what I own, stocks that benefit from the average American being better off have done the best.

I’ve got to think of different ways to increase my exposure to this theme. I’ll shop in the dark corners of my holdings, where the underperformers invariably hide, for the money to do this.

–what’s done well over the past week or so. Everything, especially Hong Kong and my wretched tech stocks. I thought yesterday was particularly interesting, in that the more defensive stocks I own–VZ and SLG (a reit)–were down throughout the day. AAPL was, too (I don’t own it but it’s on my screen). I take this as showing that short-term traders were selling defensive stocks to pour money into more aggressive names. (This is, of course, the opposite of what I’m suggesting we should do. That doesn’t bother me. Quite the opposite.)

This can sometimes mean we’re entering a new stage in a multi-part upward movement. This time I think it’s more likely to signal that we’re seeing dumb money entering the fray just as the market peaks.

summary

The last thing any long-term investor wants to do is to make an all-or-nothing bet on the level of the market. But the fact that we’re back at 1400 makes me want to tweak my portfolio around the edges. I’m doing this in two ways: I’m looking for underperformers to show to the door, and I’m looking for large positions that have outperformed where I can take something off the table. I also want to keep a close eye on the 1420 line. If the market breaks through on the upside, I’ve got to reassess my tactics.

July 19, 2012

We’re well and truly in the summer doldrums. This isn’t just the normal I’d-rather-be-at-the-beach attitude the biggest world stock markets adopt when the sun is out and the weather is hot. We’re also in the midst of a clear–and, to me, somewhat surprising economic slowdown that’s become evident both in government reports and in the results publicly traded companies are now reporting.

There are two aspects to the slowdown. It’s partly a function of economic events that are happening now. But it’s also, rightly or wrongly, partly the anticipation that worse awaits us down the road.

On the one hand,

–it may be, as Mr. Bernanke is suggesting, that the pent up demand for purchases postponed during 2007-2009 has finally–in all areas save housing–been satisfied. So world economies are naturally slipping into a lower gear.

On the other,

–as I wrote last month, until recently the EU has been doing an uncannily accurate imitation of Japan circa 1990, suggesting that Europe’s first Lost Decade might just be unfolding before our eyes.

–American businessmen (the Fed, too) are clearly worried about the “fiscal cliff” Washington may drive the US economy over at yearend. The consensus says that the lame duck Congress will fix this issue after the November election. But Washington remains dysfunctional. And neither presidential candidate appears up to the job of governing. So no one wants to bet their capital spending money or increase their new hiring budget on a favorable outcome.

Nevertheless, world stock markets seem to want to go up from here. At the very least, they don’t seem to want to go down a lot.

what to do while we wait for events to unfold

Most people actually go to the beach. Some just hide under their desks.

There are, however, more constructive actions to take at a time like this. For instance,

–Take out a fresh sheet of paper, or call up a blank spreadsheet, and sketch out a new portfolio for yourself from scratch. Don’t think about what you own now. Just indicate what you would do if all you had was a pile of cash.

Compare the result with what you own. Adjust as necessary.

–Analyze your stocks’ performance during periods when the markets are going down, and again during periods when the markets are going up.

Defensive stocks should do well in the down periods and lag when the indices are going up. Aggressive stocks should shine during the ups and sag during the downs. That doesn’t give you any information.

If you have stocks that do well in both environments, that’s great. Figure out what’s driving them and consider adding more.

If you have stocks that are chronic underperformers, you’d better carefully go over the reasons why you own them–and whether you still want to make those bets.

–In times of weak growth, market share shifts back to first-tier firms from second- and third-. INTC/AMD is a good example, I think. You want to won the former, not the latter.

clouds dispersing?

My sense is that the extreme pessimism that has covered Wall Street recently is beginning to dissipate. The EU seems to be taking constructive action at last. And the idea that China is only growing at 6%-7% (shudder) no longer seems like the end of the world. True, nothing much has changed in the US, but the election is still a ways off.

We’ll know more as we see investor reaction to 2Q12 earnings reports. So far, I think it has been fact-based–and generally favorable. I don’t think this means that the indices go up much. I think that awaits more clarity on whether Washington can create a fiscal plan that deals with domestic macroeconomic problems.

But if I’m correct that the world is still growing and that excessive negative emotion has already mostly worked itself out, there will be a good chance of making money in well-chosen stocks.

VZ, for example, hit an all-time high yesterday. INTC went down in the aftermarket when it reported on Tuesday, but rallied strongly (and justifiably, in my view) yesterday. More on this as I write about 2Q12 earnings reports. Even WYNN, which had a thoroughly forgettable quarter, was up most of yesterday before ending down only slightly. Maybe the market is beginning to discount a stronger twelve months ahead of us.

June 11, 2012

recent market action

In a broad conceptual sense–and, incidentally, from a shamelessly US-centric perspective–we might explain world equity market action since the beginning of the year as having two phases. In the first, very strong monthly employment gains in the US reported from December through March fueled a sharp stock market rally. In the second, weak employment news in April and May suggested that the earlier strength was simply seasonal hiring being pulled forward by unusually warm winter weather. That let the air out of the equity balloon and the market returned to the level where it opened the year.

This can’t be the whole story, though. First of all, the US market was rallying long before the favorable employment reports came out. And it also started falling in advance of the first of the recent weaker numbers. More than that, the US has been, relatively speaking, a beacon of equity market strength. Particular weakness has been emanating out of the EU.

Why should the S&P 500 settle around the 1270-1300 range?

From a chart perspective, that’s where the market spent much of last year. It corresponds to 13x historic earnings for the index, or an earnings yield (1/PE) of 7.7%. In other words, anyone who buys stocks at this level is getting a 7.7% annual return on his money (admittedly, you don’t get this return in the mail; it stays in the hands of corporate management). That compares very favorably with the yield on government bonds. It’s also a return that investors have demonstrated over the past couple of years that they’re content with.

bailing out the Spanish banks

Over the weekend, the EU has found a face-saving way for Spain to accept bailout money for its myriad of smaller banks that are loaded with bad property and construction loans.

To my mind, the interesting aspect of this action isn’t the bailout itself. It’s the hint that the EU has finally decided to address its financial crisis directly and pragmatically, rather than simply hoping it either go away or heal itself. If so, the EU doesn’t suddenly become a land of milk and honey, and every equity investor’s favorite destination (although deep value investors appear to be flocking there). At the very least, however, it may mean that the worst of the panicky selling emanating from European investors is over–and that the rest of the world’s equity markets will be less volatile as a result.

the two key issues, I think

the discounting mechanism

Let’s assume I’m reading the EU situation correctly.

Let’s also assume that China’s interest rate drop last week shows it is fully committed to boosting its domestic economic growth (as opposed to fighting inflation).

Both would ultimately be very bullish developments for equities. On the other hand, the fact that both actions are needed implies that near-term economic news from both areas may not make for the most pleasant reading.

The big question: will the markets care more about the longer-term positives or the near-term negatives?

In a healthy market, or when stocks are very cheap, investors will ignore the negatives. In a weak market, or when stocks are very expensive, investors will ignore the positives.

Where are we now?

One other factor–my sense is that we’re in an era where there are many more short-term traders involved in buying and selling than has been the case in the past. Their modus operandi is to react to news rather than anticipate it.

My guess–and that’s all it is–is that we’ll still have market weakness when poor company or macro news emerges about the EU or China. But it won’t be long-lasting. If so, I think they’ll be buying opportunities.

the US

As and when China and the EU recede from the forefront of potential economic problems, their place will likely be taken by worries about the US.

I had a colleague who began writing twenty years ago that neither major political party in the US has an agenda that spoke to the needs of modern America. Both are mired in the past. He was ultimately laid off because talking about this didn’t bring in enough commissions from brokerage customers. …a modern Cassandra? …or maybe everyone in the market already know this.

But big picture stuff, like unemployment, education or energy policy aside, a certain amount of housekeeping is necessary for Washington to do.

Two tasks stand out to me–raising the debt ceiling and avoiding the “fiscal cliff” that’s looming for early next year. The “fiscal cliff” is potentially more dangerous, since the combination of ending a series of temporary tax reductions and implementing mandated cuts to government spending stand to push the domestic economy back into recession.

The consensus opinion is that in the end Congress and the White House will come to their senses at the last minute and take needed action. But there will certainly be bouts of worry along the way.

what to do

I regard developments in the EU and China as real positives. The recovery in the US is broadening and deepening, though some of the strength is being obscured by the country’s chronic high unemployment. World stock markets also seem to me to be on a firmer footing. That’s partly because prices are lower, partly because the most recent news has been favorable.

I continue to think we should look for stocks that benefit from the widening of recovery in the US. Beneficiaries of structural change–wireless comes to mind–are also typically very strong relative performers in a time like this where overall economic growth is tepid.

May 14, 2012

World stock markets have taken on a decidedly defensive tone. “Bearish” is probably too strong a word for the performance of the S&P 500, since that index has only declined a bit less than 5% from its peak in early April. But European markets have been roiled by political turmoil and have declined by 15% since peaking in mid-March. As occurred last year as well, European selling has had a disproportionately negative effect on emerging markets.

I say “European selling” since it seems to me that the major damage to Asian markets is being done during the European morning. But the truth is probably that traders worldwide are reacting to (negative) news being released by and in the EU.

Greece …and the rest of the EU…in a (my) nutshell

Developments in Greece–today’s negative sentiment is a result of the country being unable to form a government after recent elections–continually provides fresh fodder for short-term traders. But neither the Greek economy nor its stock market are big enough to make much of a difference in world affairs.

What post-election confusion seems to me to be showing is that there’s no political will in Greece to repay the huge amount of debt that euro membership allowed it to pile up over the the past decade. There may be no ability to do so, as well. I suspect the final outcome will be a Greek default and an exit from the euro. That’s bad for holders of Greek sovereign debt, but otherwise the country is too small to matter.

As for the EU as a whole, I continue to think it’s Japan circa 1992 all over again. As regular readers are doubtless sick of seeing me write, the two consecutive Lost Decades in Japan resulted from a social decision to preserve its traditional way of life, even at the expense of economic growth. The EU wants the political and economic clout that comes with acting as one collective entity. At the same time, it seems to feel that it’s more important to preserve the traditional political structure, where power resides almost exclusively with the individual countries, virtually none being delegated to the EU level. This is the road to slow/no economic growth–and world stock market irrelevance.

In 1990, Tokyo was as big as all the rest of the world’s equity markets combined. (Hard to believe, isn’t it? But as Casey Stengel said, “You could look it up.”) Today, the rest of the world is easily 10x as big. Tokyo is a backwater. More significant, other than initially higher day-to-day volatility, its fading into the equity market woodwork had virtually no negative effect on the rest of the globe. As things stand now, I think that’s the long-term story for the EU.

what to do

As I’ve been writing for a long time, Europe continues to be a special situations market–one to pick and choose one or two individual stocks in, not make a huge commitment to. The best stocks will be ones that have most of their operations elsewhere.

As for the US, the 1Q12 earnings report season confirms for me that the recovery is slowly broadening and deepening. But there’s not enough economic energy to make every company a winner. In this kind of environment, the strong get stronger, as they take market share from also-rans. Individual stock selection will be the key to success.

technical analysis

As has been the case since the recovery began in 1Q09, the charts will probably continue to be more important than fundamental investors like me want to concede.

As I see it, we’re now testing the 1350 level on the S&P 500, which is the where the index flattened out in February, before bouncing up to its April highs. If 1350 fails to hold, the next stop down would likely be 1300, where the index spent the second half of January.

fight or flight?

The tendency of most investors, including professionals, when the market turns a little ugly is to just not look. If the alternative is to do some highly emotional–and therefore usually really crazy–rearranging of your portfolio, then this may not be such a bad idea. Better, though, would be to try to upgrade your portfolio.

Observe what stocks are showing unusual strength or weakness. Examine the latter very carefully to see if the fundamentals are weakening. If so, sell. Think about adding to the former. Also, take a look at stocks you’ve always wanted to own but thought were too expensive. A time like this could be a chance to buy.

April 23, 2012

It’s been a month since I’ve updated Current Market Tactics and the S&P is basically unchanged. I continue to think the market is locked in a narrow trading range for the time being, for the reasons I outlined last month. If so, the important story for us as investors won’t be the movement of the index. It will come in other areas. For example:

high daily volatility

While we’re waiting for more fundamental information about the world economy to develop, I think day-to-day volatility in individual stocks will be relatively high. Why? Funds flow data show that individual investors are continuing to allocate money away from actively managed equity products and into bond funds (who knows why) and passive equity products like index funds and ETFs.

Institutions are following a similar pattern as they hope against hope that the new hedge fund managers they are hiring will–contrary to past for–deliver outperformance, and enough of it to make up some of the difference between the size of their assets and the (much larger) size of their obligations to present and future pensioners (good luck with that strategy).

Both trends mean that the steadying hands of long-term, knowledge-based investors are being removed from the market tiller in favor of short-term traders who love to surf market “noise.”

This makes the messages contained in stock price movements harder to decipher. Happily, it also means that the rest of us can potentially find unusual bargains in the stocks we know best, as short-term traders push prices to extremes, based on hunches or “hot” tips.. That’s one thing we can keep busy with for the time being.

“the trend is your friend” …until it isn’t

The counter to the “trend” cliché is “Trees never grow to the sky.” I’m not sure either is particularly useful for anything other than justifying what you already want to do. Nevertheless, I now see four areas where I think established trends are in question:

–There’s been a lot of recent discussion in the financial press about whether world stock markets will have a mid-year swoon in the way they did during 2010 and 2010. The argument for a pullback is simply that one happened, unexpectedly, in 2010, and, again unexpectedly, in 2011. Therefore, one will happen again in 2012.

If things were only that easy!! I won’t elaborate here, but I don’t think a three-peat is likely.

–The best strategy from 2009 into 2011 was to emphasize companies that cater to a global audience (not just US) and to the affluent, who weathered the recession relatively unscathed. Several months ago, as the US recovery began to broaden significantly, the market has shifted to more US-centric firms and toward ones who cater to all of the 85%+ of the workforce currently employed.I think the shift has just started and that it will have considerable legs.

–Investing is like baseball. Life is, too. Your team can’t dominate the entire game. Eventually the other side gets a turn at bat.

Some of this–call it competitive response–seems to me to be happening in the tech world. The general idea of competitive response is that when one firm in an industry creates an innovation that gives it a commanding lead over others, the rest of the market double its efforts to create a competing–or even superior–product. Eventually they succeed, at least to some degree and for some period of time.

For instance, in its Spring laptop review, the Wall Street Journal has very favorable things to say about Windows-based ultrabooks. Also, QCOM appears to have confirmed in its recent earnings reporting that the Taiwanese foundry TSMC is having yield problem. This creates problems for all the chip design firms who’ve dominated the mobile area for years. It also gives at least a temporary advantage to integrated manufacturers like Samsung and INTC.

I’m not sure how widespread this response of the (up until now) have-nots is, nor how long-lasting it will be. But something appears to be happening.

March 21, 2012

The US stock market seems to have stalled at about 1400 on the S&P 500 and 13,000 on the Dow. Media commentators are giving their usual weird explanations for the to-ing and fro-ing around these levels. Worries about Greece or about China (or relief that neither Greece nor China are as bad as feared) are high on their lists.

I think the overall macroeconomic backdrop is increasingly clear. And it’s at least benign and probably more than that. The US economic recovery is being sustained and is broadening to reach beyond the top quarter of the population as employment expands. The EU might turn out to be little worse than flat this year, rather than being a big drag on world economic growth. Japan is loosening money policy. So, too, is China.

The legitimate point being made by bears is that the unusually mild winter weather during 1Q12 may have “stolen” some strength from 2Q12 as spring projects begin early. But I think this point is more surmise than argument based on concrete evidence. A better one might be that low winter heating bills have temporarily given consumers more money to spend.

If not macroeconomic softness, then, why has the market begun to stall?

I think it’s simple arithmetic being done by investors. If the S&P 500 is likely to earn $110 a share this year and we apply a PE multiple of 14 to that figure, we arrive at a target for the market–based on 2012 earnings–of 1540. From where we are now (1405), that would be an advance of just under 10%. That’s probably a large enough potential gain to dissuade traders from selling their positions, but it’s not enough to get people to commit new money.

So, until something changes, we’re probably in a narrow trading range. Up a few percent and the urge to take profits grows, down a few percent and traders will jump back in. Within this churning, economically sensitive sectors, particularly IT and Consumer Discretionary, will probably continue to make relative headway.

What could change the situation? Two things, in my opinion:

1. As new information arises, the market could decide that S&P earnings per share won’t be $110. If so, my guess is that the new number will be higher. That would cause the market to move. Or the market could decide to apply a different multiple to S&P earnings. Historically, a 14x multiple is associated with a Treasury bond yield of 7% or so, so there’s arguably scope for the market PE to expand. On the other hand, we know interest rates are at emergency low levels and will be rising again as the economy strengthens.

I’m not willing to bet the farm on either possibility, but they both still exist.

2. As time passes, the market’s focus will shift from 2012 earnings to 2013. Over the past several years, this transition has taken place in the waning months of the year, in October or even November. That’s very atypical. In a normal year, the move begins to occur in June or July and builds steam as we enter the fall.

It’s way too early to think about 2013 earnings in more than the most general terms. I’d guess that we’ll be playing broadening recovery in the US, signs of life in the EU and the return of emerging economies to higher growth. Set against that will be fiscal policy is in the US + the first leg of interest rates rising from their ICU-like lows. The bottom line will probably be mildly positive, with investors gradually shading their portfolios toward emerging markets and away from the US.

A reasonable target for the S&P 500, based on 2013 earnings, is probably around 1700 (a number I admittedly just made up). As investors begin to factor 2013 into their thinking, the market should regain its upward momentum. If the optimists are correct that broadening economic recovery is buoying sentiment, this shift might happen sooner rather than later.

I think this is more likely than that either the market PE expands or that the S&P earnings prove significantly better than now expected. It isn’t a bet the farm kind of idea, either, but it’s enough for me to retain my pro-cyclical portfolio posture (it never takes that much, in my case) rather than begin to take profits in my winning stocks.

February 15, 2012

Negotiations for a second, €130 billion Greek bailout are at a critical juncture–and, like patrons enduring a mediocre musical for the tenth night in a row, investors don’t seem to care any more.

Throughout months of haggling over bailout conditions, Greece has used the same negotiating tactic time after time. It will agree to terms, let the other side announce success to their governments and to the media–and then reopen talks asking for more concessions. This is not a way to establish a warm, long-term economic partnership. But Greece isn’t interested in that. It wants to buy time and to extract every last ounce of economic benefit from the other side.

In the latest iteration of the process, the Greek parliament voted in favor of an EU/IMF austerity program–except for about €350 million. More important, the heads of Greek political parties were supposed to pledge that they would not renege on this agreement after elections in the Spring. That didn’t happen, either. In fact, at least one has already declared that he will disregard the deal if his party comes into power.

It seems to me that the light bulb is finally beginning to come on in the minds of the EU/IMF side. EU leaders, who have cancelled a meeting with Greece scheduled for today, are concluding that a new bailout would be throwing good money after bad. They appear to me to be steeling themselves to allow a default and toss Greece out of the Eurozone.

What’s interesting is that world stock market don’t seem to care very much. True, the dollar rose a bit. But when this development first surfaced yesterday during New York trading, the stock market sagged initially. But it fell by less than a percent–and then rallied just before the close to finish up on the day.

Two conclusions:

–investors are concluding (correctly, in my opinion) that there’ll be no “Lehman moment” (where world trade comes to a sudden halt and mass layoffs ensue) as/when Greece defaults. Having been pondering the situation for almost eighteen months, they no longer fear widespread contagion in the Eurozone (Portugal) may be an exception, but–like Greece–it’s too small to matter).

–why should markets pause at all? Stocks have risen over 20% since October and are due for a period of consolidation. And there’s always a final bit of discounting when bad news actually occurs. So buyers are probably waiting for any default-induced weakness before making purchases. That makes sense to me, too.

My bottom line: yesterday’s trading is a very bullish sign, in my view.

January 23, 2012 (third anniversary of CMT!!)

Price action in the S&P 500–as well as in Hong Kong and (unfortunately, for my social media stocks) in Tokyo–looks to me a lot like what happens in the initial stages of a new bull market. I don’t think that’s completely correct conclusion, but it gives a quick picture of what I think will be the winning portfolio orientation over the coming months.

Two factors are behind this new market enthusiasm, in my opinion:

–the US economy, despite Washington’s best efforts at disruption, is coming out the far end of the recession tunnel it entered during the financial crisis. Employment stabilization/recovery is broadening out to embrace more than just the affluent; and the housing market is bottoming. I’m not a big believer in the wealth effect, but even I can see that the end to decline in the value of the most important asset the average American holds, his home, is a positive for consumer confidence.

–investment money from around the globe is flowing into Wall Street. Even modest economic acceleration looks good in comparison to what’s happening in the rest of the world.

Pro-cyclical sectors like Materials, Industrials, IT and Consumer Discretionary are all on the plus side of the market’s +4% advance so far this year; defensives like Utilities, Staples and Telecom are not only underperforming but are showing losses in absolute terms as well. My guess, right now anyway, is that this relative performance pattern will continue for the next several months.

My reaction? … buying shares in MAR and MCHFX.

I don’t think this is the start of a new two-year run of bullish news. We enjoyed that already from March 2009 through June 2011. A three- or four-month decline, even one whee the S&P drops by 20%, isn’t enough to reset the clock. But, if I’m correct that the depressants of an awful housing market and of sky-high unemployment are abating, stocks will act in an early bull market way for a while.

Two caveats (the potential show-stoppers I see):

–the Eurozone could take a turn for the worse. The World Bank just issued an economic report that says an implosion of the euro would clip 4% from world growth in 2012, causing a global recession. Stock markets don’t believe that anything remotely like that outcome is possible, based on the argument that politicians can’t be that stupid. There’s nothing in today’s prices for an EZ accident. Quite the opposite. Markets seem to be saying that the worst is over.

–I think the prevailing Wall Street view is that the current high level of unemployment means that the US economy still has plenty of slack in it. In other words, there’s no chance that interest rates will rise any time soon. I worry that high unemployment is structural. Europe, for example, has such a bad mismatch between workers’ skills and employers’ needs there that unemployment hasn’t fallen below 75 for twenty years. If the US is in a similar situation, credit tightening could be a lot closer than the markets are now factoring in.

There’s also the issue that the trend rate of real GDP growth in the US, which used to be 3%, is probably now south of 2.5%; Europe will be lucky to average 1%. This means there’s a limit (1400 on the S&P?) to what investors are going to be willing to pay for earnings sourced from the developed world.

But, for now, I intend to sit back and enjoy the ride.

January 13, 2012

Crosscurrents often make the first couple of weeks of January difficult to read. For one thing, there’s the” January effect,” which consists mainly in the bounceback of last year’s dogs depressed by tax selling in December. Then there’s the selling of last year’s winners, whose capital gains taxable investors want to recognize in the later tax year. Also, some professional investors only initiate their investment plans for the new year in January (why they wait is a mystery to me, but I’m convinced they do).

Still, I have several observations:

Before I start, a plug for me. My “Shaping a portfolio for 2010” series is worth taking a look at. It’s in six installments–

1. Press comments, either on the global economy or about individual stocks, currently have an unusually negative spin. That, of course, is bullish. And, true to form, stocks are showing themselves to be unusually resilient in the face of bad news. True, retail stocks reporting a disappointing holiday selling season are getting crushed. But companies with a story of bad news now but of profits deferred are not. I have a small position in a speculative stock, DRWI, for example. The stock has been an awful performer. The company reported a horrible miss after the close Wednesday and was down 13%+ in early trading yesterday. Ouch!!! By the end of the day, however, it was flat.

2. Dividend paying stocks continue to get a long look from investors–and a lot of publicity. The news spotlight makes me a little nervous. Still, I think there’s some mileage left in the idea. In a year when (I think) being up 10% will make you a hero, having a well-covered dividend that gives you a yield preference over the S&P in a stock sensitive to the US business cycle is probably going to be a very good thing to have. A couple of years ago, when you could reasonably be thinking being up 20% or 30% from a bear market bottom was possible, a 100 basis point pickup in yield over the S&P was nothing to write home about Today it is.

3. Don’t go overboard playing the improving US economy. Yesterday I turned on CNBC while I was ironing a shirt and heard Cramer say investors should think about selling WYNN to buy MGM because of the latter’s greater exposure to the US gambling market. That’s loony. If we were back in 2009 the idea of buying a highly financially leveraged second tier company on the idea that it could be the biggest beneficiary of a change in investor perceptions might have some merit. But that’s not where we are now. We’re not talking about the US economy going from -1% growth to +6% for a few quarters. We’re talking about one going from +1% to +2%–or maybe +3% for a little while, if we’re lucky.

There won’t be enough extra demand in 2012 to make the burden of weak operations and high leverage go away. Housing may be another story, but generally I think it’s a mistake to do more than reorient toward high quality names with large exposure to the US economy.

December 23, 2011

The unusual December continues. Normally, we’re deep in shutdown mode by this time in the final month of the year. Many global stock markets will be closed for much of next week. Only skeleton crews of junior staff will be manning their desks at brokers and investment managers. Auditors will already have requested portfolio managers to refrain from trading, if possible, so that as few unsettled trades as possible will complicate their annual perusal of the books.

This year, in contrast, markets continue to be unusually volatile as they react to every nuance in the Eurozone’s attempt to deal with its financial crisis. A lot of this movement is jockeying by short-term traders who are trying to decide what they want their book to look like over the Christmas holiday weekend.

That’s not all that’s going in, though–at least in my opinion. Professional portfolio investors are also mulling over the implications of developments in the Eurozone, although their deliberations cover a much longer time frame.

Their economic question is: Suppose we’re facing another “lost decade” (or more) in another large part of the global economy. In 1990, the area in question was Japan; now it’s the EU. How badly will a flatlining Europe depress economic activity there? …for how long? What ripple effects will there be for the rest of the world? If we take the Japan simile seriously, which I do, the answer is no net economic growth for as far as the eye can see–and maybe then some.

Their (more crucial) investment question is how much of this potential grim picture is already built into today’s stock prices. The market’s answer seems to me to be that quite a lot is already discounted, and that the risk of further disappointment is offset–at least outside European bourses–by surprisingly strong economic news coming from the US.

I don’t expect the S&P to run away to the upside, and I’m not willing to bet the farm on the idea, but it seems to me that the index is trying to stabilize above 1200. Technicians’ fears that we may have to “test” the August/October lows of around 1100 may prove groundless.

The very good news coming from the US is persuading me to do something, though. I didn’t given my personal portfolio much of a defensive tilt over the past half year (and my relative performance shows that fact). But I’m slowly starting to reverse the few defensive measures I have taken. This is well ahead of when I was planning to do this even a couple of weeks ago.

December 15, 2011

this isn’t a normal December

what usually happens

The vast majority of professional investors are paid based on their calendar year performance. By this time the year is already made or broken; it’s too late to influence the full-year numbers one way or the other. So professionals are doing three things:

–vacationing, so they’re not tempted to do something really stupid

–reviewing/developing strategy for 2012

–making mild tweaks to their holdings.

Individual investors are doing yearend tax selling.

Taxable professionals, like banks or insurance companies, are doing the same.

There’s typically an offset to this seasonal downward pressure on prices–a continuing bounceback from September-October tax-related selling by US mutual funds. But as far as I can see mutual funds haven’t done much of that this year. Yes, October was an up month, but set up by the summer’s wicked swoon, not by mutual funds.

This may seem like splitting hairs, but I don’t think it really is.

I interpret the selling of the past five months as being caused by the Eurozone’s woes–and as being spearheaded by the behavior of Eurozone investors. This makes a difference–in my mind, at least. The selling looks more like what happens in a bear market than like year-end portfolio adjustment. In particular, the big winners of the past 30 months are no longer winning. This defensive rotation has been at least as important an influence on performance as the changes in index levels.

I’ve remarked in recent months that the markets seem to be gravitating toward larger, more mature, dividend-paying stocks. Over the past few weeks they are becoming defensive at an accelerating rate. My guess is that there’s more of this in store for early 2012. Eurozone countries are supposed to have ratified the agreement reached last week by next March. That’s the date I have in mind for Europeans to become reconciled to the recession that’s in store for them and for investors to begin to plan intelligently rather than let their emotions run wild.

There are a number of positives that have emerged over recent months. China is adopting a pro-growth money policy after an extended period of encouraging slowdown. The US economy is showing surprising signs of strength. And the situation in Washington is looking slightly saner. World stock markets, however, are not interested at the moment in hearing positive news, only negative. That’s a bear market attitude.

I don’t think this is a garden-variety bear market, either–though I should remind you (and myself) that I’m better at navigating through good times than bad and that I tend to be too optimistic.

To start with the most basic conclusion, I don’t see this as late 2008 all over again. World commerce is not going to grind to a halt. The US is going to expand, not slow down. Instead, although there will doubtless be ripple effects, recession is going to be confined to 20%-25% of the world–the Eurozone. I think the European Central Bank will adopt a more expansionary money policy to help combat the downturn, but not until after all countries have signed off on treaty changes.

Let’s say that Europe is growing at +1% now and that austerity measures will force that down to -4%, which would be one whale of a recession (I’m just making that number up, to try to get an it-can’t-be-worse-than idea of how 2012 will play out). A loss of 5% in the GDP of 20% of the world would mean a loss of 1% in GDP growth for the entire globe. Even were that to occur, the world would continue to expand, just at, say, a 3% rate next year, rather than 4%.

I don’t think it will be this bad.

Scroll down to my August 17, 2011 comment, if you want to see a simple translation of my thinking into S&P 500 earnings.

My most-likely-case conclusion: trough eps of $75 sometime in 2012; fair value of the S&P 500 based on trough earnings at around 1170.

For the index, then, I expect a kind of bear market that will express itself more in time–at least until March–before stocks can think of going up again, rather than in significant index declines from here.

My greatest worry: from May 2nd until early August 9th the S&P fell by 22%. Since then–even with the recent selloff–the index has risen by 10%. Will we have to revisit the August low before this down market is over? My guess is no, but the possibility is worth thinking about and game-planning for.

November 25, 2011–a post-Thanksgiving addendum

I’m in Connecticut celebrating Thanksgiving with relatives.

I’m writing this on my daughter’s computer because I somehow didn’t pack my own when we left home yesterday morning. Forgetting my computer is something I never do. I figure my mind is telling me I’m getting too hung up looking at the minutia of the stock markets’ daily fluctuations. I’m going to listen to the message my unconscous is forcefully delivering to me.

Stepping back to look at the forest:

the current situation

–ex the EU, world economies are expanding. Notably, the US seems to be perking up after a mid-year lull

–nevertheless, world stock markets have been selling off for about four months

–during the selloff, there has been a marked rotation toward defensive names, with the big winners since the bull market began in early 2009 being the biggest losers

–part (most?) of the motivation for the decline is an amazing, and continuing, deterioration in the market for Eurozone sovereign debt

–stock valuations are very reasonable, even assuming global earnings growth is barely above zero for 2012. Lowered expectations for next year are an important secondary reason for the decline

my personal portfolio

–it peaked in terms of relative performance when the market did during the summer. I’ve lost most of that back since then–enough that my unconscious is telling me I’m becoming frozen looking at the screen. For what it’s worth, this situation usually arises when a negative market movement is pretty long in the tooth

what I’m doing

The standard steps are to examine the overall strategy, investigate any names that have been serious underperformers, and look at relative performance with an eye toward upgrading the portfolio. Between bites of leftover turkey, I’m doing all three–with my mind’s admonition not to get too tangled up in random short-term price variations

short-term stuff anyway

I think 1170 on the S&P represents fair value for the market. The key technical question is whether support at 1150 will hold. If not, 1100 is the next level to look at.

The key psychological question is when selling in the Eurozone government bond markets will abate. That’s anyone’s guess. In the absence of surprisingly strong consumer spending results out of the US, I think that it will be hard for the equity markets to show real strength while this emotion-driven liquidation continues. Upgrading holdings is the most useful thing to do in the interim.

November 22, 2011

As you can read below, a month ago I was relatively optimistic. The US economy was then–and still is–flashing signals of turning up. The “bad boys”Eurozone, Greece and Italy, were being dragged clicking and screaming into facing up to their parlous debt situations. And a social consensus in Italy, by far the more important of the two countries, seemed to be forming to finally deal with its festering economic sores …just as it did two decades ago in order to qualify for membership in the Euro.

And, of course, equities are cheaper now than they were then. Stocks in the US are down about 8% in the intervening month, and European indices have fallen by close to 20% in US dollar terms.

Two new factors have entered the equation, however.

1. The palpable (if irrational) sense of fear causing–and caused by–selling in European bond markets is giving pause to optimists around the world. It’s not just financial markets, though. Companies have begun to alter their inventory behavior, cancelling or postponing orders as they begin to think it’s better to lose a potential sale than to have unwanted merchandise on their shelves. So the economic uplift is becoming more muted.

2. The US congressional “supercommittee” tasked with figuring out how to shave a couple of percent from the government budget has dissolved into partisan bickering, declaring itself yesterday unable to do its job. That’s added to current selling pressure. I don’t think that’s because automatic across-the-board proportional spending cuts will be triggered instead. I think Wall Street is beginning to consider that the Oval Office may just be Mayor Bloomberg’s or Governor Christie’s for the asking (after all, the incumbent is less popular than the universally loathed Richard Nixon–who’da thunk it), and that large chunks of the current Congress are going to be tossed out in the next election. The real issue is that no one knows yet what the new guys will be like.

I find myself in the odd position that I’ve always made fun of in others. Prices are a lot lower, but I’m a bit less enthusiastic.

It’s not that I’m so pessimistic, or that I feel I should alter my personal portfolio much at all. I’m beginning to think, however, that it will not only take more time than I thought for the new government in Italy to make enough progress to calm nerves there, but also that a whole new arena of uncertainty has opened up in Washington. (On the bright side, at least Barack Obama didn’t appoint Jon Corzine as Treasury Secretary–imagine how much money might have gone missing then!)

I’m not sure what to call the sideways-moving market I’m now anticipating for the next few months. It’s not a bull market. It’s not a typical bear market either.

If you consider being an equity portfolio manager as like sailing a small boat in a big ocean, I’d say that the storm clouds I thought were dissipating have decided instead to give us some more days of choppy seas and rainy weather.

Still, bear market terminology may be useful in explaining what I see to be going on.

A bear market normally has three phases:

—hope, the period after the market has peaked but before investors have figured out what’s happening,

—boredom, when stocks have already made their first low and when investors realize that no good economic news is on the near-term horizon, and

—despair, a final selloff, usually just as economic news has passed its worst,but as investors (incorrectly) begin to think the skies will remain black forever.

I think we’re possibly settling into boredom, as we wait for political developments, not economic ones.

I see no need for a final cathartic selloff, mostly because I think the world is in far better economic shape than the consensus is willing to admit. I think Europe is at the bottom and the US is ready to shift into a (slightly) higher gear if Washington doesn’t muck up the works.

I am starting to think about one risk I still think is improbable, but not being as inconceivable as I might have thought a month ago. What happens if the affluent quarter of the population in major countries–which accounts for at least half of total consumer expenditure and which has been rock-solid for the past two years–starts to worry and begins to save? (I know the answer, and it isn’t good.)

As I’ve been writing elsewhere, I’ve been getting a little more large-cap lately and a bit more tech-oriented, while paying more attention to dividends (INTC, for example). I’ve also taken some profits in stocks that have been big winners and where the positions have gotten too big. Position size didn’t bother me three months ago, however, so trimming positions is a way of getting more defensive. It’s also a way of getting money to use to rotate ahead with the market.

I’d anticipated getting more interested in beneficiaries of stronger overall global growth, on the idea that continuing good news from the US and Asia would gradually better and spread more deeply into world economies. That’s on hold for now–which is the only concrete action I’m taking.

As events play out, I suspect I’ll be writing more frequent updates here than just once a month.

October 26, 2011

straws in the wind

It seems to me that Wall Street is beginning to gravitate toward large-cap cyclical stocks after a very long period of dalliance with a relatively small group of secular growth names. Examples:

CAT reported 3Q11 results a day or two ago. It endorsed the high end of its prior earnings guidance for 2011 (eps of $6.75-$7.25) and suggested that 2012 would be up at least 10%, and possibly up 20%. Wall Street securities analysts had been (grudgingly, I expect) clinging to the low end of the range. Less than three weeks ago, CAT was trading at around $68, or under 9x forward earnings. It’s now around $90, but still looks cheap to me.

INTC is a similar case, with powerhouse earnings, a single-digit multiple, very strong performance since early October and continuing analyst skepticism.

On the other hand,

AMZN reported overnight, saying it might lose money in 4Q11 as it promotes its new line of Kindles, including the high-end Fire model, very aggressively. The stock is off by about 13% in pre-market trade as I write this. This stock trades at about 100x eps. Analysts (maybe I should put that last word in quotes) are expressing shock the Jeff Bezos might put market position higher in his priorities than short-term profits–which means they’re completely clueless about both about AMZN’s history and what it has already been attempting in the e-book arena from the outset.

At the same time, leading indicators in the US are beginning to perk up a little from their summer doldrums. And global stock markets have already mostly factored in the likelihood of a European recession next year. True, the EU remains a wild card, with at least some chance that the outcome from its banking/Greece/what-are-we? crisis will be substantially worse than just a small minus in the GDP growth column for 2012. But just the fact that the drama is so drawn out means that the likelihood of another post-Lehman moment (when, economically, the world stood still for months) is extremely low–and shrinking.

I don’t think the markets have a great chance of going up before we have a better handle on the EU. But it seems to me that a valuation-led, and sensible, in my opinion, market shift toward cyclicals is under way. Maybe this move will have legs and maybe not. As a growth investor and eternal optimist, I think it may last. If you want to participate, think big cap and low multiple, my friends.

September 14, 2011

I’m content to watch and wait while European fears about Greece play themselves out in world stock markets. Actually that’s not quite true–I ended up buying a small amount of INTC when it broke below $20 just before Labor Day, and again when it approached $19 on the following Tuesday.For me, the 4%+ yield and a PE below 9 proved too tempting.

1. The S&P 500 reached an intraday low of 1101 on August 9. The index rebounded a bit before turning down again toward the 1101 low, on August 19-22. This was too soon to count as a “test,” in my opinion. However, after rebounding to around 1220, the index fell back a second time, arriving at 1140 on September 6 and September 12. I think this last movement does count as a valid test of the August 9 low. The low may well be tested again. But it would be very encouraging news if the 1140 level could hold.

2. September 6 was a day of considerable panic in the US market; September 9 and 12 seemed to me to be days of extreme panic in Europe. It’s premature–but still tempting–to think that the discharge of built-up fears through a surge of irrational selling indicates that worst is over for the markets for now. Even if it isn’t, we’ve got to be well along the way to discounting the most probable bad-news scenarios for Greece.

3. Invariably when the market is making, or is about to make, a significant change in tone, the pattern of market leaders and laggards changes. It’s important in the transition and in the early days of the new movement to identify the new trends. What jumps out to me over the past two days is that GARP (Growth At a Reasonable Price) names with significant profit exposure in Asia are doing surprisingly well.

My central thesis remains that the markets move sideways until investors become convinced (as I think they will eventually) that the current level of earnings represents a trough. That could take a couple of quarters. During this period, I think there will be a sharp separation between the performance of companies whose earnings continue to grow strongly (and whose stocks will outperform significantly) and those whose profits stagnate or decline.

I also think the announcements by China and Brazil that they want to aid the EU in its current crisis are very interesting. We should all monitor the BRICs’ actions closely.

August 18, 2011

Today’s topic is what to do with the three brief scenarios I outlined yesterday.

First of all, an observation:

US-trained portfolio managers as stock pickers

American professional equity portfolio managers are usually former securities analysts. Domestic PMs operate in a market where the biggest deciding factor in performance is selection of individual stocks. As a result, Americans are very reluctant to have their portfolios depend radically on analysis of the macroeconomy.

PMs use two main strategies to try to mitigate their portfolios’ correlation with broad economic movements. Value investors will select stocks they believe are exceptionally cheap, based on one or more valuation metrics; they hope this will cause their portfolios to fall less than the market in bad times. Growth investors select stocks they believe will achieve surprisingly strong earnings growth; this will enable their portfolios to rise more than the market in good times.

Despite these tactics, no investor can, in my opinion, avoid answering the question of whether the market is likely to go up or down and factoring his conclusion into portfolio construction.

three scenarios

The three macroeconomic scenarios from yesterday were:

nothing’s wrong price target for the S&P = 1430

muddling through price target = 1170

recession ahead price target = 1000.

drawing conclusions from them

1. formulating expectations. …being a little more precise, both about what you think, and what’s already baked into the market.

In late June, for example, I would have said that the chances of nothing wrong were about 60%, muddling through 25% and recession 15%. The weighted average of these expectations–sometimes called an expected value–is 1300. The market, with the S&P then at around 1350, was a little more bullish that I was. Even so, I was writing that I thought there was a good chance for the market to go higher.

Right now, i’d change those odds to: muddling through 50%, nothing wrong 30% and recession 20%. The weighted average is 1214. The market is considerably more bearish than that, as I’m writing this. 1145 on the S&P 500 is more consistent with a 30% chance of recession and only a 10% chance of nothing wrong. So even though I’m less bullish than I was two months ago, I’ve gone from being less bullish than the market to more bullish.

2. Although fooling around with numbers can be fun, and it forces you to think about your assumptions, it can lead to a false sense of precision. It may also prevent you from getting as much depth in your judgments as you can. After all, many thoughts may be directionally correct but not very precise. That’s why I see the main use a portfolio manager can put the formulation of various cases as being qualitative.

For example,

I’ve changed my mind. Two months ago, I would have written (and actually did write) that nothing wrong was the most likely outcome for the US economy and that recession was by far the least likely. I now think that muddling through is the most probable, with recession promoted to second place.

What does this mean for my portfolio? It doesn’t mean that I start to add defensive names to my holdings to tone down the risk level. But I’m now aware I have to think more about downside protection. This will mean I have to consider changing the types of risk I build into my portfolio.

I’ve already been leaning heavily toward firms with international exposure, on the idea that growth outside the US will be better than growth inside. I probably won’t change that–other than to consider carefully whether I want any EU earnings streams. But I will shift a bit away from firms that deal with other companies–a kind of endeavor that’s highly economically sensitive–and focus moe heavily toward ones with consumer exposure. I will alsohave to reconsider a company like AAPL (which I don’t own), which is on the leading edge of innovation and can therefore generate strong earnings growth even in a lackluster economy.

I also know that I have to scan more intensively to find possible negative information about the US or global economies, to make sure that things aren’t worse than I now assess them to be.

An ugly market day like today can be a good time to make switches of this type, since everything seems to be falling in tandem.

August 17, 2011

Where to from here?

We’ve seen crazy movement in the S&P 500 over the past month. We started at around 1350 (with me musing about the possibility that we would break through to the upside! …something I’m a little embarrassed about now). We lurched downward in short order to just above 1100, bounced off that level twice, and burst back upward to 1200–all in about four weeks. Whew!!

A first step in mapping the way forward–not necessarily the first step, but in this case the way I’m choosing to start my analysis—is to ask what caused the unusual market movement.

three factors

I see three new factors that have entered the market’s (or maybe just my) consciousness over the past month:

— The US Fed’s second round of quantitative has ended; the central bank has made it clear that QE3 is not on the cards. At the same time, it has indicated that the zero interest rate policy will continue for at least the next two years–meaning it thinks strong economic growth is unlikely over that time span.

–After contentious partisan debate, Congress extended the federal debt ceiling, thus avoiding a partial government shutdown. The whole episode illustrates how difficult it will be for Washington to agree on anything, meaning there’s zero change of any economy-boosting fiscal measures—or fundamental reform of a complex tax system/too expensive entitlements apparatus—any time soon.

–The EU has failed again to put anything more than a band-aid on its Greece-related financial problems. (An aside: economic commentators are beginning to compare the current US situation with Japan in 1990. May be. But one of the signatures of the first “Lost Decade” in Japan was Tokyo’s failure to address the weak capital structure of its banks for ten years. In fact, the government actively encouraged its financial institutions to paper over their bad loans. In this regard, the EU resembles Japan much more closely than the US does.)

What does all this amount to? …the training wheels have been taken off the US/EU economic bicycle. Economies will have to make it on their own steam, without government help, from now on. In hindsight (wisdom coming only at twilight, as Hegel put it), I think this is what global stock markets have been absorbing over the past few weeks—the fact that we have less certainty that profits will be growing over the coming year or so.

consumer confidence is hard to gauge

We know that economic activity has slowed down over the past few months. Part of this is due to poor weather. Part is the natural spending decrease that occurs when pent-up demand built up during recession is satisfied. Part is certainly due to damage done by Washington’s display of ineptitude. Part probably also comes from supply-chain disruptions caused by the Fukushima disaster in March.

All these factors are temporary. The big question is whether they explain all of the slowdown or just a little part of it.

No one knows—or at least I don’t.

making reasonable guesses

That’s all we can do. Let’s examine three possible economic outcomes:

Case 1: nothing is wrong. In other words, the recent decline is just a correction in an ongoing bull market. That was my initial tkae (note the past tense). If so, S&P earnings are likely to be 100 this year and, say, 110+ in 2012. Assuming the market continues to trade on the 13x current eps that it has over the past while, an implied target for the S&P would be 1430 over the next six-nine months. That’s about a 20% gain from today’s level.

Case 2. a typical recession is on the horizon. Let’s say that means a 25% decline in the S&P’s eps from the 100/year level of 1H11 to a trough of 75 sometime next year. If we assume a 13x multiple on the latter earnings, that would imply a low for the index of around 1000. That would be a 15% drop from today’s level.

Case 3: something in the middle. It seems to me that there are two mitigating factors in today’s market situation.

–A typical (business cycle/inventory adjustment) recession starts with real GDP growing at an above-average rate of perhaps 3.5% and falls to -2% before the worst is over. That’s a decline of 5%-6% in real economic output. Today, we’re barely growing at all. On the analogy that you can’t fall off the floor, it might be that an economic slowdown means a decline in output of 3% instead. That might mean an S&P profit decline of 15% instead of 25%–and no growth, but no further decline, for an indeterminate period afterward.

–To the extent that the geographical source of S&P profits is disclosed in corporate filings, income seems to come in the following proportions: 50% from the US, 25% from the EU and 25% from emerging markets.

If we assume a 15% decline in US and EU profits and a 10% rise in income from emerging markets, the overall profit decline in a downturn would be about 10%, to 90 for the S&P. Applying a 13x multiple gives a target of 1170.

That’s it for today. Tomorrow, how to use these data in portfolio construction.

August 3, 2011

I’m a bit bemused by the carnage we’ve seen in world stock markets over the past few days. After all, in macroeconomic terms, not much has changed.

I’m also observing my own attitudes. My initial thought is to write something that’s more bearish than I did a month ago (see my July post below). Of course, on the face of it, that’s the wrong way to think. Bullish at 1350, bearish at 1250 typically means you’re too caught up in the emotion of the minute and are not calmly and rationally thinking about investing. Nevertheless, I wonder if a sea change in sentiment hasn’t occurred over the past month.

the economy

Economic signs are decidedly mixed. On the one hand, the best of the Las Vegas casinos are running out of rooms to rent–the city isn’t, just WYNN and LVS. Customers are beginning to fork over $10,000-$20,000 for a Harley, for the first time in five years. $600 smartphones and tablets are flying off the shelves. On the other, industrial companies are reporting some signs of flagging demand, and the US GDP needle is barely above zero.

There are several possible elements to the reported weakness:

–maybe demand is truly falling off (I doubt this is the major reason),

–we may be seeing a mild tweak downward of inventory levels at retail–after all, why have supply chain software if you’re not going to use it,

–it may also be that crazy rhetoric and actions over possible government shutdown and sovereign debt default have scared the American people and are causing the nation to become more cautious on spend (this is certainly the case, but I’m not sure how important this factor is).

Only time will tell what the real mix of factors are. My money is on inventory adjustment + Washington antics.

the change in market mood

It’s possible that the downward movement we’re now experiencing is the market adjusting to the start of the US’s return to a balanced Federal budget–even though the first faint fiscal tightening will take place a year or more from now. That fiscal adjustment would have to take place at some point should not come as a surprise to anyone who can read. But current Wall Streeters don’t seem to show a flair for discounting any event far in advance, and, no matter how well-known an event is, there’s always some reaction when it actually occurs.

what I’m doing

We’re back down at what I consider to be the bottom of the market’s trading range, at S&P 1250–actually we’ve broken below that figure, intraday, as I’m editing this. My normal impulse over the past couple of years has been to buy, maybe aggressively, at a time like this, depending on where I saw value. I don’t have that same strong desire today, despite the fact that yesterday’s market showed the earmarks of panic selling–sharp declines and the collapse of even the stocks of even the finest companies, which has been holding up well until then.

I’ve decided I’ll wait to see if the 1250 line holds, however. The next step down would be 1200, where, as things stand now, I think I would be a strong buyer.

Why my hesitation? I can’t put my finger on a really good reason. It may be, as I wrote above, that I’m not thinking clearly enough. It may be that I’m happy with my holdings as they are (I am). It may be because year-to-date I’m way way ahead of the index. It may be that the intensity of the selling over the past week or so says that there’s still more to come.

I’m content to see evidence the market is stabilizing before acting. That’s tactics.

Overall, however, as I’ve recently written elsewhere, the environment looks to me to be favorable for stocks. Fiscal contraction means interest rates will stay low for much longer than most people (me included) understood a year or two ago. Valuations are reasonable. Beneficiaries of technological change and companies with significant Asian exposure stand to do well even in a stagnant US economy.

July 8, 2011

Wow! That was quick.

We’re back at the top end of the 1250-1370 trading range the S&P 500 has been establishing for itself. And the heavy lifting was done in only eight trading days.

Recent market action illustrates that a significant market movement–particularly to the upside–can happen quickly and can come out of nowhere. The relevant market clichés are:

–that it’s time in the market, not timing the market that counts; and

–that all the upside of a bull market is packed into 10% of the trading days–missing them is disastrous to performance.

The point is that the answer to “What happens next?” is of little strategic significance, though it has tactical importance.

Nevertheless, this is a page about tactics, not strategy.

So, what does come next?

Let’s first observe that nothing much has changed with the two big macroeconomic negatives in the world, namely, the possibility that dysfunctional politicians in Washington will cause the US to default on its sovereign debt, and that their runners-up in the ineptitude derby in the EU will fail to deal with Greece, which is bankrupt in all but name.

The second situation has been defused a bit, however, by EU suggestions that it will in effect order its banks not to honor any Greece-related credit default swaps they may have entered into, thereby removing the threat of potentially ruinous losses (no one knows what they may be) from any contracts European financial institutions may have entered into.

In the US, the ardor of extreme deficit hawks seems to have cooled a bit as they learn the basics of economics (Ireland is a particularly sobering example of too much austerity). So it’s now looking like a package of tax hikes and entitlement program cuts will emerge in time to allow Congress to vote in favor of increasing the federal debt limit.

Nevertheless, neither threat has disappeared. And (my next cliché) nothing is ever fully discounted until the event occurs.

Also in the negative column, as I’m writing this the latest BLS Employment Situation report has been released. It shows continuing weak job creation in the private sector, erased almost entirely by higher layoffs by state and local governments. The report follows a very bullish announcement on new hiring by payroll processor ADP which issued the results of its (quirky) monthly employment survey earlier in the weak, and by surprisingly strong sales for June being reported by many domestic retailers.

How these conflicting currents sort themselves out in the next few days will give us more insight into what I think is the burning tactical question of the day: do we break out of the S&P’s trading range to the upside, or do we meander around at the current index level for a while, before heading back down toward 1300 or 1250 again?

It may just be my bullish nature, or maybe a strong contrary streak, but I don’t think it’s a slam dunk that we head back down. Why not? …the strength of the recent advance, the strong retail sales number, the FedEx comment that the current “soft patch” is mostly due to temporary weakness emanating from Japan + $4 a gallon gasoline. In addition (more clichés), the conventional wisdom says the trading range pattern will repeat, but the market makes the biggest fools out of the greatest number of people. Also, in June/July the market usually starts to discount potential profits from the following year, which should be some what higher (I think) than those of 2011. This process only began in September last year, but it seems to me the economy is substantially stronger now than then.

I’m not saying I want to get more bullish than I’ve been. All I’m thinking is that I want to wait a little bit before taking short-term profits. Today’s trading will likely provide some more evidence. Recovery from an opening low would add to my optimism; deterioration throughout the day from the opening would give me pause.

June 22, 2011

are we starting to move up again?

Certainly looks that way. The S&P made an intraday high of 1370 on May 2nd, before beginning a 31 trading day descent that brought it to an intraday low of 1258 on June 16th. That’s a 9% fall.

This action looks very similar–both in duration and extent of the fall–to the seven week decline the index experienced in May-June of last year, when the S&P fell from 1217 to 1080 (minus 11%) before rebounding.

One difference: this year’s late spring correction appears to have bottomed at the low made in March; in 2010, a time when economic conditions were considerably shakier than they are now, the index only found support at levels established late the prior year.

As I’ve written several times before, and taking a very simple point of view, I don’t think these periodic corrections have much to do with the headlines of the day. Instead, they seem to me to be based on short-term considerations of relative valuation …in other words, whether there’s enough sort-term upside in the market to justify making a purchase (admittedly the discounting mechanism is influenced by the macroeconomic “big picture,” and the latest Bureau of Labor Statistics Employment Situation report may have capped one’s ability to dream of a vast expanse of possible upside). Once the market has reestablished enough upside, say 10%-15%, buyers reemerge and the market stabilizes.

Based on this idea, a decline of around 10% is probably enough to bring buyers back to the table. It also seems to me that until we get better labor market news, the S&P may continue to bounce around in a range from 1250 to 1350. If so, two courses of action are in order:

–for investors willing to trade a portion of their portfolios, 1250-70 would seem to be a time to add and 1350 or so is probably a time to lighten up. This isn’t the only consideration, and you should only trade a small portion of your position. But if a stock seems fully valued, 1350 is as good a time as any to take a profit.

–more important, everyone should look at the relative performance of their stocks during any correction and during the ensuing rebound.

The easiest way I’ve found to do this is to use the charting program of some financial news service (my favorite is Yahoo’s). Get a chart of the S&P during the correction and use the compare function (a fancy way of saying to enter the ticker symbols of the stocks you own and look at the performance of the name relative to the S&P).

A value investor should expect his stocks to outperform while the market is going down and underperform on the rebound. A growth stock investor should expect his stocks to be relatively weak during correction but to outperform during the following up phase. You can hope for more, but this should be your minimum expectation. Both types of investor should expect to outperform over longer periods of time.

In most instances, this simple exercise only serves as a sanity check for what you hold and doesn’t give you much information. But there are two situations that are especially worth noting, whether you’re assessing stocks you own or whether you’re prospecting for new names.

They’re the ones where the stock either outperforms during both phases–in which case you may have an exceptionally good stock–or where the stock underperforms during both phases. This is usually a BIG red flag.

June 16, 2011

searching for a bottom

It seems like longer ago, but it’s less than three weeks since I wrote my May 29th commentary below, in which I argued that market circumstances are substantially better this year than they were in 2010–and that, in consequence, market action would be stronger this summer than it was during the market swoon the accompanied the advent of warmer weather last year.

I’d also had an extended run of pretty good success at calling the short-term direction of the market. Of course, that’s a little like being very good at juggling, impressive but not extremely useful. And now I’ve dropped my juggling pins in a big way for the first time in a while.

What’s happened?

A whole set of indicators have reported in their latest readings that the US economy is slowing down to a greater degree than anyone (or at least, I) had anticipated. Part of this may be due to supply-chain problems from earthquake/tsunami damage in Japan in March. That part will gradually fix itself. But the larger portion of the slowdown–the near halt to new job creation in the US is a particular sore point–likely comes from other causes. Maybe it’s that, two years into recovery, pent-up demand from the recession has exhausted itself and we’re finally seeing the true, sustainable rate of growth in the US economy–and it’s pretty pitiful.

Yes, there are external factors–the EU economy has ground to a halt as the constituent states repeatedly fail to deal with the financial mess Greece has made of itself. They all know what needs to be done; but voters won’t be happy and politicians are spending their time scrambling around to find someone other than themselves to pin the blame on. Also, Beijing continues to gradually add to contractionary measures–which it’s been doing for well over a year.

All of this raises the level of uncertainty for world stock markets. Two consequences:

–when all else fails, investors look for past patterns to imitate. As I wrote late last month, last summer resembles this summer–and now to a greater degree than I’d thought.

In addition, the “debate” on raising the national debt ceiling to avoid default on government bonds is eerily similar to the runup to the initial vote on bailing out the financial system in early 2009. When Republican legislators voted against the bailout–effectively saying they would prefer to risk subjecting the country to a repeat of the Great Depression of the 1930s rather than rescue fat-cat bankers, world stock markets immediately dropped by close to 10%.

Despairing of trying to figure out current fundamentals and resorting instead to trading on the idea that past patterns will repeat themselves, is more a change in sentiment than anything else. But neither pattern that investors are likely looking at encourages one to take risk.

–the future time frame whose earnings investors are willing to incorporate into today’s prices contracts. My sense is that before the May Employment Situation report, investors were beginning to reflect in current stock prices the possibility that earnings per share for the S&P 500 in 2012 would be around $115, up by 15% from the $100 a share that’s likely for 2011. Now, up 10% would seem to be the more likely number. But, for the moment, that whole question is off the table. Stocks are being priced, at best, to reflect full-year 2011 S&P earnings–say, $100, and maybe less.

When can we expect good news to reemerge? I’d separate this into two questions–good economic news and good market news. The second could come earlier than the first.

Other than developments on the EU or US political front, the next testing moment for the markets may well come with the June Employment Situation report in early July. Who knows what it will say. My guess is that it confirms the poor new employment number reported early this month. “Good” market news would be that investors simply shrug the report off and don’t react negatively. Lack of reaction to negative news is typically the first sign that the market is establishing a base from which to potentially move higher.

The June quarter earnings report season is still quite a few weeks away. My guess is that there won’t be many positive surprises when companies reveal their results. I don’t think there will be many negative ones, either. But I also think that if I were a CEO, I’d see no percentage in making super-positive comments about the course of future business. If so, the market may not be able to regain a bullish tone much before Labor Day.

Looking at the charts, the key figure I see is the 1250 level that the S&P briefly breached on March 16th.

As always is the case in a period like this, the best use of any investor’s time is in upgrading your portfolio–pruning weak companies and adding to strong firms that are excessively hit by bearish sentiment.

May 29, 2011

Summer’s almost here!!!

It’s the Memorial Day weekend, the unofficial start of the summer vacation season in the US. It’s also finally stopped raining.

looking back a year

By this time in 2010, the S&P 500 had already peaked and was well into a 16% slide, after which it would meander around until the weather started to get cool again in September.

Several factors triggered the 2010 swoon:

–the market was relatively fully priced, given expectations for earnings, when the decline started,

–the domestic economy was slowing,

–fiscal problems were flaring up again in Europe,

–Washington was its usual dysfunctional self, and

–uncharacteristically for the second year of an uptrending market, investors were unwilling to discount more than a month or two into the future.

some things remain the same, …

Even though it’s a year later, it seems to me that the same factors apply again. But as Heraclitus, the Yogi Berra of the pre-Socratic philosophers, is reputed to have said, “You can’t walk through the same river twice.” (–or, maybe it was “You can’t get there from here.”).

…but there are big differences, too

In any event, several other factors have changed for the better:

–enough net new jobs are being created to slowly eat into the unemployment rate,

–we have another year of economic growth and good stock market performance behind us,

Funds flow data and the charts bring out the differences in behavior between a year ago and now very clearly:

According to the Investment Company Institute, investors took $25.1 billion out of equity mutual funds, a rate roughly equal to withdrawals during panic selling at the bottom of the market in February-March 2009. Through the 18th of this month, the latest data available, there were net withdrawals, but they amounted to about $2.9 billion.

Looking at the charts, the S&P peaked at around 1370 in early May, drifted downward to the vicinity of 1320. It has bounced off this level twice and appears to be headed upward again.

stock market worry about government bond default has dissipated

Don’t ask me why. It sounds like the best we can hope for from Washington will be a resolve to make cuts after the 2012 election, implicitly allowing the electorate to decide what spending will be pared by deciding who will be in office at that time. Maybe that will be enough.

one more thing to ponder: when will the bull market end?

We’re in year three of uptrending stocks. In June or July, investor thoughts typically turn to what they think will happen in the following year. Wall Street securities analysts, who are inveterate trend followers as a group, aren’t much help. They’re projecting another up year for earnings in 2012–by 10%-15%. That may well end up being the case, but I think the buy-side numbers are simply extrapolations of the current environment.

At some point, this will become the key issue for the market, since the S&P will either be driven higher by price-earnings multiple expansion (possible, since the current multiple of under 14x seems on the low side to me–but I wouldn’t count on it) or on investors beginning to discount expectations for 2012. Actually, I’d be happy if the market moves sideways until September, when the 2012 situation will be clearer.

I think the world will likely benefit from rebuilding of structures damaged in the Japanese earthquake/tsunamis, whether that takes place in Japan or elsewhere. Emerging economies will also continue to expand. I think 2012 stands to be an up year on those factors alone, assuming both the US and Europe at least tread water. But I’m content to wait before betting more heavily on this outcome.

restructure portfolios? it’s too soon, I think

It seems to me that there are enough opportunities to make money in mobile devices and related infrastructure, travel and leisure, luxury goods and emerging economies to keep an aggressive portfolio stance, even in the event we ultimately conclude that the S&P will only be up modestly next year. The fact that the market is still climbing a “wall of worry” is encouraging. Still, it’s not too soon to be thinking seriously about how 2012 may play out economically. Since the only bad outcome for stocks will be if next year is significantly weaker than the current one, a prudent investor will be on the lookout, not only for positive signs, but also for evidence that this may be the case.

April 24, 2011

Happy Passover!! Happy Easter!!

This is more an observation than a tactic.

About a half-hour before the market open on Monday April 18th, S&P put US sovereign debt on negative credit watch. As S&P explained in its press release, it said it was skeptical that Washington could agree on deficit reduction actions before the national election in November 2012. This would imply no actual measures in place prior to, say, 2014. If so, the rating agency concluded, there was a reasonable chance S&P would be compelled to downgrade Treasury bonds–taking away the country’s AAA-rating–before then.

The Obama White House said S&P was underestimating Washington’s ability to get anything done (as if that were possible). Others called it a “political” move …meaning either payback for Congress having excoriated S&P for its having given AAA ratings to subprime mortgage-related securities, or an attempt to get Washington moving before it’s too late. Still others said S&P was too “naive” to understand the complex workings of the legislative process. Put another way, politicians called S&P a lot of names instead of rebutting its assertion.

Based on what has happened in past US fiscal crises, notably in 1987, I’ve argued that the first sign investors are taking a warning like S&P’s seriously (and I think it should be very worrying) would be that domestic investors would abandon the bond market. We’d know that by seeing a rise in the interest rates on Treasuries.

What’s happened during the past week, you ask? Nothing like that.

Stocks immediately dropped by 2% on Monday morning, with economically sensitive issues falling far more than that. But the market began to rebound a little before noon, and hasn’t looked back since. In the following three and a half days, the S&P is up by 3.3% and is again touching resistance around 1340. Cyclical stocks and issues with non-US exposure have led the way.

Bonds have been rock-steady, with some maturities even gaining slightly in price.

The dollar, however, has lost about a percent in value, both against the euro and the yen.

Admittedly, it has been only three days, but what do strong stocks/weak dollar mean? I don’t think the combination is consistent with a belief that Washington is going to address the deficit. It suggests, rather, that the government is going to do nothing and hope that a combination of economic growth and a weak currency will somehow solve the country’s problems.

The current situation differs from 1987, I think, in two key regards:

–today, stocks are cheap relative to bonds; in August 1987 (the market top) 30-year bonds were yielding 10% and the S&P was trading at 20x earnings (or twice the value bond prices would justify)

–individual investors in the US have made a massive commitment to bonds during the recession, providing perhaps a more stable base of holders of Treasuries than back in the Eighties.

So I don’t see a looming 1987-style stock market crisis. And I don’t see the need at the moment to shift from an up-market strategy.

Still, I think the situation bears close watching, with an eye to possibly becoming more defensive. Government bond prices are the obvious indicator. The performance of Staples is another, because the sector is both defensive and has large non-US exposure. Therefore, it may be an early warning indicator of upcoming stormy weather.

April 12, 2011

When the S&P 500 began its rebound from the March 16th low, I expected the index to encounter initial resistance at around 1300. That level proved absolutely no problem for the S&P, however. The index paused there for only a day or two before moving smartly upward again.

1340, the near-term high established in February, is proving a tougher nut to crack, though. By my count, the S&P has approached 1340 three times in the past week or so and been repelled sharply. If you wanted to include April 1 and April 5 as failed attempts to breach the 1340 barrier, I wouldn’t quibble too much. The point remains that exceeding 1340 is probably going to be hard.

Assuming that’s correct, the near-term technical question turns to whether we find support at 1300 or at 1250-1260. I have no strong opinion.

It’s also interesting to note that recent sectoral outperformance is to be found in Healthcare and Staples, two defensive industries, as well as in year-to-date laggards Consumer Discretionary and Financials. An uptrending market is always a two-steps-forward, one-step-backward affair. The catch-up of laggards while former leadership moves sideways or down is the hallmark of a consolidating market …which is what I think we’re in now.

I should note that in saying this I’m not “reading” the charts; I’m imposing my interpretation on them. I’m taking the market signs the way I am because I think 1400 or so is the consensus target for the S&P based on 2011 earnings. As I’ve been remarking since February, this objective gives investors no incentive to put new money to work once the index reaches 1330-1350. So until either quarterly earnings reports demonstrate that earnings are much better than Wall Street now thinks–which I doubt will happen–or until investors begin to want to discount earnings gains from 2012–which probably won’t happen until summer–I think the S&P will find it hard to make new highs.

I don’t think we should read anything into the possibility that the S&P may stall around here for a time. This is just the way stocks work. As always, it will be interesting to study the near-term trading patterns for clues to what other investors are thinking. And, as always, a time like this offers an opportunity to upgrade one’s portfolio–or to work out a little longer in the gym.

A comment (a footnote, really) about Alcoa (AA). The company reported March quarter results after the close on Monday. As I’m writing this, the stock is down about 3.5% in the aftermarket, apparently because quarterly revenues fell 1.6% below analysts’ expectations.

I’ve looked very carefully at AA, including many of its subsidiaries and joint ventures, very closely on several occasions over the years. I’ve found it to be a very complex company, with an incredibly complicated supply chain. In fact, I don’t think it’s possible for an outsider to make an accurate estimate of quarterly revenues; I don’t think it’s any piece of cake even for an insider, either.

I think investors with natural resources experience know this. As a result, I regard market reaction to minor deviations from the brokerage analysts’ consensus as more an indicator of market sentiment than an intelligent reaction to the quarterly report. So, in AA trading later on today, I expect we’ll learn something about the near-term mindset of the market–bullish or bearish–from how the stock fares.

March 24, 2011

mistakes

Any professional equity investor eventually has to come to grips with the fact that, even at the top of his game, he’s wrong at least 40% of the time–probably more. Some people just can’t deal with it.

If you have enough self-mastery to be able to check your ego with your coat when you come to work and take the large error rate as a fact of life, you soon come to realize that there are lots of ways to be wrong. But, at the risk of sounding Rumsfeldian, mistakes fall into two main categories:

–decisions you know are costing you performance, and

–decisions you’ve made that are costing you performance, but you’re unaware of having made them or how much they’re costing.

Finding this information out is why you have periodic performance analysis–preferably with performance attribution reports.

Mistakes of the first type you can easily fix by eliminating the offending position. Or you can draw the (dangerous) conclusion that you’re right but the market is temporarily too dense to see this, and maintain the position in the hope of future gain.

Mistakes of the second type are more insidious, because you aren’t conscious of the decision and what it is costing. How can mistakes like this exist when you have detailed performance analysis in front of you? There’s a powerful psychological tendency to interpret data in a way that confirms your most deeply held beliefs. In my experience, your eyes just hop over the lines with the red ink on them. It’s something you have to constantly fight against.

where I’ve been wrong recently

Why am I writing about this? I’m aware that I’ve been wrong recently in three areas, and I want to write about the third of them.

The three are:

1. I’ve been horribly wrong about ATVI as a stock. I’ve been selling my position into the recent correction, but in hindsight I held on much too long. …oh, well.

2. I’ve been maintaining two incompatible views about the IT sector. I’m very overweight technology in the model portfolio. But I also think that virtually all the outperformance in IT from this point on will come from smaller companies. The sector’s biggest problem is that most of the heavily-weighted stocks are holdovers from previous generations of technology–MSFT, INTC and CSCO are prime examples. In the case of INTC, I think the stock has already completed the difficult journey from being a growth stock to being a value name, so it will probably be ok–not great, but ok. But many of the other big constituents of the sector have barely started on this trip.

I’ve believed this for a while, but I haven’t been able to come up with a way to address the issue without selecting individual stocks that will exhibit hair-raising amounts of volatility in their prices.

3. (The thing I really wanted to write about in this post) I’ve thought that as the bull market matured and the US economy returned to growth that the effectiveness of technical analysis would diminish and the fundamentals would count for more.

Why would I think this?

I view technical analysis as a tool for studying the behavior of other investors. It can alert us to when they’re highly emotional and doing crazy things (either buying or selling). And it can show us unusual trading activity, which may well signal the presence of people who are “in the know” and are buying or selling on information that’s much superior to what we have. In this regard, the heyday of technical analysis was the first half of the last century. That was before the SEC demanded fuller disclosure of corporate information, before ERISA sparked the creation of a highly professional cadre of analysts and portfolio managers, and before computers and the internet made locating and analyzing information much easier and cheaper. In today’s world, we have almost infinitely more to work with than invesors did in the Thirties. To use a backwoods metaphor, using technical analysis as your main tool today is like bringing a knife to a gunfight–not the best strategy.

Despite what I think, technical analysis isn’t fading away. In fact, it seems to have been as effective as ever in the correction we’ve just experienced. I have several theories–but theories are like third-basemen: if you have three it really means you don’t have any.

There’s a bottom line from this meandering comment:

We can see places on the current S&P 500 chart where there’s been a significant amount of buying and selling. The relevant ones are at 1250 and 1300. If the index is above one of these lines, the line is potential support. If the index touches and bounces back up, the support is confirmed (meaning you can have more confidence it will hold if tested again). If the index falls below it, the line becomes resistance, or an upper bound, above which the index will struggle to rise.

In the current market, 1250 is support. 1300 is resistance. It will be interesting to watch how hard the 1300 line will be to crack on the upside.

March 16, 2011

–

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Take my survey, if you haven’t already. It’s brief, anonymous and it will help me focus future posts. Thanks.

1) You can say that a lot of terrible stuff has happened recently, namely:

–sovereign credit downgrades on the EU periphery

–regime change in Egypt

–civil war in Libya, including bombing of oil wells and loss of some of that country’s highly-prized output

–a devastating earthquake–100x the size of the one that flattened Haiti a year ago–in Japan, crippling the third largest economy in the world

–a nuclear reactor disaster caused by the subsequent tsunami–complete with meltdowns, explosions and escape of radiation into the atmosphere.

As a result of all this, world stock markets have been flattened. Look at the newspaper headlines! What a horrible situation!!

2) Alternatively, you could say all this stuff happened, but the S&P 500 is only down, even on an intraday basis (which makes the decline bigger), by 6.2%! Year to date, in fact, the index is up by about 2%. Investors must be really bullish.

the technicals

Actually, there’s a third way to approach the market. Forget about all the macroeconomic and political stuff and just look at the charts.

I find myself ambivalent about doing this. I’ve never minded puzzling over the charts in Asia, because I know that they form an important part of the psychology that drives the markets there. But throughout my career I’ve been trained to think that technical analysts in the US are a bit like fortune tellers–colorful but not to be relied on. Nevertheless, throughout the current bull market, charts have been more useful guides than usual. It may be that so many fundamental researchers have been laid off and so many trading professionals are running hedge funds that chart patterns are becoming more important in the US. This would be a bit like horse-drawn wagons replacing eighteen-wheelers as a way to ship goods from place to place. But maybe it’s still true.

Anyway, when the S&P was at 1344, the charts were saying that the market was too high. If you set a target for the year of 1400 or so, investing would only get you 4% in eleven months–not enough to take the risk of buying stocks. So a correction was called for.

How deep? 10% might be a good number–implying that the S&P would have to touch around 1260 to restore value. We hit 1261 at the low yesterday. That might have been good enough. (See my post from March 7th, below, for more details).

my thoughts

I’m a growth investor, so I’m always going to be inclined to pick the second line of reasoning above–that is, that recent price action shows a strong underlying bullish tendency. Selecting the psychologically easier alternative is something be on guard against (so, too, is excessive second-guessing). Nevertheless, I think the bullish interpretation is right for the current situation.

The charts seem to agree.

The fact that my personal portfolio fell apart a few days ago, after holding up surprisingly well for the prior several weeks, also suggests to me that the correction might be getting long in the tooth.

What am I doing? Nothing. It’s possible that if yesterday was a low point, the market will bounce a bit and then return to “test” the low. I might be a buyer if that happens. But I’ve been aggressively winnowing my holdings over the past month and I’m now happy with what I own.

If TIF were in the 40s I’d probably buy some more. If I’d stayed up all night on Monday (NY time), I might have bought more DeNA when it dropped below ¥2500. I was even tempted a little at yesterday’s close of ¥2660. But the stock opened today at ¥2790 and I already own a lot of it. Same story for DeNA’s smaller competitor Gree, except I don’t own much. The low yesterday was ¥990, the close ¥1090. It opened today at ¥1240. This illustrates how panic-filled Tokyo trading has been since the earthquake.

I don’t expect a rush back to the highs of a month ago. Were that to happen, we’d be in the same correction-prone situation we were in mid-February. I expect that markets in the US and abroad start to drift back up over the next few weeks. But mainly they’ll busy themselves with selling stocks that have held up well and using the money to buy stocks that have been punished without good reason. There’s still time to upgrade your portfolio, if you need to.

March 7, 2011

Is this a correction we’re in now?

I’ve recently written about corrections in general, partly to address this question.

To recap briefly, the dilemma the market finds itself in now, as I see it, is that in the opening month and a half of the year we were already up about 7% on the S&P 500. This means the market had all but achieved the progress (an S&P target around 1400) the consensus had forecast for the entire year. Therefore, there seemed to be little near-term reason to take the risk of buying stocks.

What to think?

I see four approaches. I’m sure there are more, but I think the ones I list below are the most common thoughts of market participants in a situation like this:

1. raise the price target. I think of this as the brokerage house, or “sell-side” solution. I see it already being applied to individual stocks and, to a limited degree, with the index as well.

This is really a marketing tactic rather than a solution, though. Brokers make more money when you trade a lot and when you have your assets in risky assets rather than cash. Experience tells them that if you sell part of your holdings, you may not put 100% back into securities that generate high income for them. Worse still, you may withdraw that cash from the account.

My take is that the current upward drift of price targets is just business-as-usual for brokers, and shouldn’t be relied on as fundamentally sound. (I do in fact think there may be a case for arguing that the market will capitalize 2011 earnings at 15X instead of 14x. It’s also possible, though less likely, that eps for the S&P 500 will be higher than $100. But I think it’s too early in the year to make either argument.)

2. Find some other good news to discount. The obvious choice would be earnings growth in 2012. However, typically the market only begins to factor the following year’s earnings into prices in June or July. Last year, as I interpret the market’s action, prices only began to discount 2011 prospects in September. In other words, I see investors as having less than their usual degree of confidence. So I think it’s much too soon to expect positive thoughts about 2012 to underpin today’s stock prices.

3. Hope that the market moves sideways until new positive news develops. “Pray” might be a better word. The market rarely stands still. It either move up or it moves down. If it can’t move up, there’s only one way for it to go.

4. Expect a correction. In this case, downward movement would probably be limited to 1250-1260 on the S&P 500.

Of all these possibilities, the fourth is to my mind the most likely by far. If we were back in 2010, we’re probably already be flirting with 1250. We’ve also at least got to consider the possibility that turmoil in the Middle East will cause oil prices to rise to a level that derails economic recovery in the US and the EU. I don’t think that’s probable, but it’s a risk that has to be kept in mind–something that should exert some downward pressure on prices.

What’s very interesting is that the “likely” script isn’t playing out.

the charts

If we turn to the charts, the S&P peaked on Friday February 18th at 1341.5. Three trading days later (Monday was a US holiday, so four trading days later for the rest of the world) the S&P briefly broke through first area of resistance at 1300. It touched 1294 before bouncing back to close the day at 1306. Since then, the index has been bouncing back and forth between 1330+ and 1300+.

What’s going on?

A technical analyst would probably stroke the fringes on his buckskin jacket, perhaps clean his nails with his Bowie knife, and say the market is forming a pennant. That is to say, if you drew a line through the short-term tops and one through the short-term bottoms, the two lines would be angling toward one another, forming the shape of a little triangular flag. The technician would say, I think, that when the two lines meet, probably in a week or so, the market will start to go either up or down decisively, depending on the relative slopes of the lines. To the degree I understand this stuff–and it had its heyday (and real usefulness) a century ago when there was virtually no reliable fundamental information available–the lines say the market will decline.

I choose to believe the week-or-so part. I’d also prefer the market to go down for a while, just to get the correction over with. But I also think technicals are very unreliable indicators. The most reasonable point the technician might bring out is that the current situation represents a temporary stalemate between forces that want the market to go down and those that want the market to rise. If I had to have an opinion, I’d think the former are investors who have been in stocks from the inception of the bull market and the latter are investors newly fleeing bonds and cash.

Absolute ups and downs aside, it seems to me two important trends are emerging:

1. The first might be called the TIF-WMT spread. You can pick other retail names, but select one that targets affluent customers vs. another whose audience is people of average to below-average means. Put both in a Google or Yahoo chart (Yahoo’s are a lot better, I think, but there’s no need to be fancy) and look at relative performance. Retailers who appeal to low-end consumers, who will presumably be hurt much more by higher oil prices, are significantly under performing their higher-end rivals. I think this pattern will continue.

2. Look at the S&P 500 vs S&P small-cap (especially small-cap growth) the same way. Small stocks, especially growth-oriented ones, are outperforming their large-cap brethren. This is to some degree the normal evolution of a bull market. But I think there’s more than this. Small-caps have little international exposure vs the S&P 500. And the IJT ETF, which is small-cap S&P growth, will also have an emphasis on firms with superior profit expansion.

My bottom line: Yes, we’re in a correction, although it’s an odd one. I think 1250 is the ultimate downside target, but we may not get there. Since I see no way to figure out anything more on this subject, my emphasis has to be on creating an investment strategy where the duration or depth of the correction has little relevance.

That’s why I think the two sub-surface trends I mentioned above are important. I’m confident there are more, if you only look for them.

February 20, 2011

This is the second of my comments on the current market situation. You can see the first one, dated 2/18/11, below.

Two years ago, the market was exceptionally difficult emotionally, but very simple conceptually. Stocks had been cut in half and were trading at extremely cheap prices, both in absolute terms and relative to bonds. So “strategy” consisted in strapping yourself in and waiting for the rocket ship to blast off. Figuring out a price target for an index wasn’t important, since once they started to move, stocks were going to go up a lot.

During 2010 in the US market participants seemed to have a mental image, both early on and in the autumn, of the S&P 500 ending the year at 1200-1250. Stocks would rally to a point, say, 1100, where the upside from owning stocks appeared to be 10% or less. Then they would flatten out and correct. When a 10%-15% upside potential was restored, stocks would rally again. (A crisis of belief characterized the middle of last year. The same trading pattern held, but from lower target index levels.)

In my Shaping a Portfolio for 2011 (II) post, I offered an initial mental target of plus 10% for the index for 2011. I thought stocks might do better than that but saw no need to make a more aggressive assumption. That would give a price target for the S&P for 2011 of 1375-1400.

The issue: in the first month and a half of the year, stocks have run from 1257 to 1343, a rise of almost 7%. Stocks don’t show much sign of wanting to correct. But a 1400 target would leave only about 4% upside for the market between now and whenever (in normal years, during the summer) investors begin to factor 2012 earnings into their calculations.

What to think?

In my post below, I suggest that what has changed is the way investors are discounting future prospects. They have become more confident and are willing to factor profit possibilities from farther in the future than they were in 2010. This process invariably reaches the point where the market overreaches and discounts a future that’s much too rosy and much too far ahead to have any idea what’s likely to happen. Then it’s “look out below”. But this is not a concern today.

If we worked as brokerage house strategists, this problem wouldn’t bother us. We’d simply raise our market target. After all, our main concern would be with generating trading volume for our firms (which is how we’d make our money), not with having our portfolios perform well.

But we’re not sell-side strategists–at least, I’m not.

Is there any way to shed more light on today’s situation, short of adopting a “Don’t worry, be happy!” creed?

Several observations:

1. We can turn the question upside down and ask what assumptions are imbedded in today’s level of the market. If we need 10%+ to justify the risk of owning equities, 1343 is an attractive level to put new money to work only if we believe that the S&P 500 can reach at least 1475-1500 by year’s end. Is that reasonable? It would be 15x the $100 in earnings I think the S&P will achieve, rather than the 14x I was willing to assume in the dark days of December. If anything, I think my guess about S&P earnings is on the generous side, so, to me, the question is completely about the PE multiple. I’d rather not bet the farm on 15x, but it’s possible–maybe easily possible.

2. We can try to say what’s too high. Rewind the video back to October 2007, the S&P’s all-time high. The market was trading at 18X historical earnings at that point, although the market was beginning to feel that profits were beginning to roll over and decline–meaning investors were beginning to worry that the market was at a higher multiple of forward earnings. On a purely psychological basis, I think investors won’t accept anything close to 18x. 16x is probably the highest we’re going to be able to stomach for a long while yet.

3. We can try to say what the downside from here may be, given that the overall economic situation doesn’t change significantly. Again, take it for granted that it requires 10% upside to get new money to want to come into the market. If we take an index target for 2011 of 1273-1400, then the trigger for inflows is 1250-1260, or about 6% below where we are now.

4. As I’ve been expecting, I;m finding the charts less useful as time goes on. 1343 seems to be in no-man’s land. There’s support/resistance around 1300 and around 1400 and little to indicate which is more likely.

my bottom line

I’ve been (incorrectly) expecting a correction for some time. Maybe that’s just being stuck in last year’s mindset, but experience tells me that it’s bad to change your views when the main reason is that prices are higher.

10% upside vs. 6% downside isn’t much to write home about on either side of the coin. My simple analysis suggests the S&P isn’t notably under- or over-priced. Any correction is likely to be mild and relatively short-lived.

A big key to 2011 will be sector positioning (read: being in economically sensitive industries) rather than participating in a large move in the index.

Another will be individual stocks, if you’re willing to take the extra risk. In this vein, the most interesting idea I’m seeing now is the buildout of wireless broadband infrastructure to support smartphones and other mobile devices. This means buying medium-sized tech manufacturing stocks, a risky endeavor but potentially very rewarding.

February 18, 2011

So far this year, stock markets are a lot stronger than I had imagined they’d be. Just look at my analysis on the Keeping Score page, or my beginning of the year Shaping a Portfolio for 2011 series of posts to see what I had envisioned.

As far as portfolio composition goes, however, I think I’ve been mostly in the right places. So the fact that the speed of the market advance has been faster than I’d thought has just meant faster absolute gains. I’ll take being wrong like that any day of the week.

What’s been happening to make the market feel so strong? Several things, in my view:

–the fact that new money is coming into the developed world stock markets, either from individuals’ cash reserves or from bonds, is a key factor. Two others are more important, though, I think. For example,

–technological change is happening at a highly accelerated pace. That’s sending the stocks of newer, smaller companies that are riding the new wave of innovation soaring. But, interestingly, the stocks of the older generation that are on the wrong side of change aren’t going down much in price. Yes, there’s the occasional CSCO or NOK on the downside, but names like IBM or even MSFT and INTC are holding up very well. Maybe this is due to the increasing preference of both individual and institutional investors for index funds. But, whatever the reason, it’s happening. The net result is upward pressure on broad market indices. Also,

–the discount mechanism is changing in form as investors gain more confidence in the idea that world economic growth is improving. Through the end of last year, investors evinced a bear market “what have you done for me lately” attitude. They were willing to pay for earnings on the day the results were reported, but not much sooner. There was no thought of anticipating, and factoring into current prices, the possibility that earnings would continue to be surprisingly good for, say, the next six months or year. That attitude has been changing into its more enthusiastic bull market analogue over the past couple of months. Investors are not yet willing to discount events that may occur over the summer. But they are increasingly is willing to pay today for profits that are only going to be posted in the March or June quarters.

What to do? First and foremost, enjoy the ride. A second task is to reexamine the overall investment framework for 2011 to see if any alterations are warranted. More about this on Sunday.

January 14, 2011 (two weeks short of two years writing this page)

We’re two weeks into the new year. Market folklore that ‘as January goes so goes the year’ to the contrary, this month is filled with cross currents. Some movements are influenced by taxable investors’ timing of capital gains and losses, and have no long-term importance. Others are the last gasps of themes that have worked in the market for a long while, and therefore should be ignored. And some, the most interesting, are indicators of emerging trends. The trick is to decide which is which.

tax selling

Most individuals have December tax years, so they sell their losers in December and their winners in the following January. The rebound of the former is the idea behind the “January effect,” the outperformance of low-dollar-share-price, poor performing, small cap stocks after a big selloff in December. I don’t see any evidence of this effect in 2011. In fact, so far this month small caps as a group have underperformed the S&P 500.

On the “sell the winners” side, the sector that jumps out to me is Consumer Discretionary, the performance champion from 2010. It’s now vying with Utilities for the bottom spot among sectors, year to date. I expect Discretionary will return to its 2010 form as profit-taking exhausts itself.

money flows

There have been a number of reports in the past month or so by organizations like EPFR and Lipper indicating that individual investors have begun to put net new money into equity mutual funds that specialize in US stocks. Figures from ICI, the industry trade association, don’t bear these reports out, however. According to ICI, every week for the last half-year, investors have taken money out of domestic equity funds. Virtually every week, they’ve put money into global/foreign equity vehicles. Other than one week of whopping profit-taking in mid-December, individuals have put new funds into taxable bond funds. Since worries have arisen recently about possible municipal bankruptcies, these flows have been partly offset by withdrawals from tax-free bond funds.

In short, not much change. That’s a good thing, however. Just as ‘the opera ain’t over ’til the fat lady sings,’ a bull market isn’t over ’til the last bear capitulates. At the risk of over-parsing a maxim, this doesn’t mean the opera/market immediately end when the fat lady or the last bear do their things. They’re early warning indicators. Another group of canaries, brokerage house strategists, have already turned extra-bullish on the S&P. But to my mind they’re much less important than the retail money flows.

growth vs. value, small vs. large

Growth managers (most of whom likely own large positions in AAPL) have been outperforming their value counterparts throughout 2010, according to Lipper. Growth stocks, however, have been outperforming value stocks only since last September. The latter trend is continuing into 2011. My strong belief is that 2011 will be another growth stock year, even if AAPL no longer leads the pack.

Small is underperforming large in January, after outperforming large through 2010. My guess is that this is another case of start-of-the-year profit-taking and that small will soon resume its outperforming ways. (The Lipper classification of large cap vs. small cap managers is a pretty loose one, but, for what it’s worth, small cap managers are achieving higher absolute returns than their large cap counterparts, although the latter are performing much better against their benchmarks than the former.)

sectors

Puzzling out information from sectoral performance in January is probably not worth the trouble. The winners so far are Financials and IT; the laggards are Telecom, Utilities, Materials and Consumer. My take is that all four of the underperformers are suffering from tax-related profit taking. It will be interesting to see which sectors bounce back. Consumer Discretionary gets my vote for most likely to, Utilities and Consumer Staples seem to me most apt to continue to lag.

strong start

Through January 13th, the S&P is up a little more than 2%. If we take my assessment that this will be an up 10% year, there’s only 8% left to be earned in index terms over the remaining 50 weeks. At some point, investors will begin to think that there’s not enough return available to take the risk of buying stocks.

Two main possibilities, in my mind:

–investors will continue to push the market higher, either thinking that 8%- is enough return to keep buying, or thinking that the index will achieve much more than up 10% this year (brokerage analysts seem to be projecting up 15% or so)

–the market will flatten out for a while, or even decline, until investors think value has been restored and start buying again.

my thoughts

I think it will turn out to be more important for 2011 performance to get the market rotation correct (toward smaller, toward growth, toward mid-and high-end domestic consumer, away from the EU) than it will be to guess the absolute level of the market by yearend. This is, of course, provided my conclusion is correct that this will be an up year.

What to do? In general, January is a month for trying to take advantage of tax-related selling to upgrade your portfolio. So a lot depends on what strategy you’ve decided on for the year. If you’ve read my Shaping a Portfolio for 2011 series, you know what I think.

It seems to me that Wall Street is taking its cue from the current freezing weather to declare that the year is over and is starting to wind down operations in preparation for the year’s end. This is about a week or so ahead of schedule.

I know that I’ve argued that as time passes, the charts will become less and less relevant to us investors. Nevertheless, I’m going to offer them as an explanation for this behavior.

A quick glance at the areas of support and resistance for the S&P shows (to me, anyway) that the market has natural stopping places at around 1200, 1300 and 1400. We closed at 1228 yesterday, an area we’ve been exploring since the beginning of the month. We don’t seem to want to go back to test 1200 again. But I can’t imagine that we can generate enough enthusiasm to make a run at 1300. The catalyst for that may well be either reports late in the month and in early January 2011 of a very successful holiday season for retailers. Or it may be the reporting of December quarter earnings for publicly traded companies, which are likely to be very good and accompanied with announcements by industrial firms of new hiring.

What to do in the mean time?

I’ve always found December to be a good time for “targets of opportunity,” as it were. There’s always someone who has waited too long to do his yearend selling and is forced to push out more stock than the market wants during a time of relatively thin trading. So he ends up depressing the price to an unusually high degree. Also, mostly in foreign markets, there’s always someone who succumbs to the temptation to “enhance” his performance by manipulating one or two key portfolio (or index constituents not held) holdings up (or down) in the last day or two of trading.

In both the case of the sluggard and the crook, it can be profitable to take the other side of the transaction.

By the way, this is also the time of year when retail investors dispose of their losers, generating losses they can hopefully use to offset some of the taxes they would otherwise pay on their sales of winners. This activity is the other side of the coin of what has been dubbed the “January effect,” the rebound of small cap, mostly speculative stocks from the selling pressure of December. Play this at your peril, in my opinion.

Of course, in any investment endeavor it’s important to have an overall plan, and to avoid being reduced to random stock picking. Stock selection is perhaps the essential skill in the US market (macro and political factors play a bigger role overseas). It’s the random part that causes the trouble.

I’m still trying to formulate my strategy for 2011, but in looking for end of the year anomalies, I’d emphasize:

–firms that earn their money in Asia or the US, not Europe

–earnings growth and not bond-like firms whose dividend yields are their main attraction

–consumer firms that cater to the more affluent rather than the less affluent.

I also think “story” stocks will do less well in 2011. That’s both because, one way or another, interest rates will be rising; and because we’re fast approaching year three of up market, where delivering earnings that more than justify today’s prices will be much more critical than merely embodying a good concept.

So it’s much better to find an anomaly in an area you like, I think, than to buy a stock that has little else going for it than that it’s been knocked around in December.

Good hunting!

More on these topics later in the month.

November 30, 2010

I was really surprised when I saw that September 24th is the date of my previous update. I’ve been think a lot over the past few months–admittedly without much tangible success–about where the market goes from here (an aside: there’s a subtle difference between thinking about the “big picture” and doing nothing, an observation I first made during my (abbreviated–I couldn’t find a job I would take) philosophy career). I guess I’ve woven it into my daily posts but not said anything on this page.

next year

My gut feeling is that next year we’re in for more of the same as this year: tepid economic growth in the developed world and rip-roaring growth in the developing world; and a sharp division between the haves and the have-nots. But that’s the consensus–and it’s been around for at least a year. In my experience, two types of people are anxiously scanning the horizon for any sign of change: first of all, there are investors who have missed the train entirely and are justifiably worried about hopping aboard after so long; and there are those who boarded early and are sitting first-class sipping champagne. At least some of the latter want to repeat their success during the next leg of market advance. They’re on the lookout for any signs that this train may be pulling into the station, its journey complete. They want to be the first to board the new express. Both classes of people don;t mind being a little early.

yesterday’s trading

That’s what makes a day like yesterday so interesting.

If I were still supervising a group of other portfolio managers, I’d ask each one to look at the performance of ever stock they own–and market bellwethers, too–to see which rallied in the afternoon. The best stocks will have declined less than the market on the way down yesterday morning and closed up for the day. AMZN is an example. The clunkers will have declined more than the market in the morning and recovered less than the market in the afternoon.

I don’t mean to say that every stock in the first group will be winners and every one in the second will be losers, but the two groups will give you an insight into what the market is thinking. I think the message is that there isn’t the great need there was a year ago to orient a portfolio away from the domestic economy, although housing-related remains out of fashion, as are stocks that benefit from consumers trading down and ones that look too much like bonds.

the EU and country bailouts

Also, for what it’s worth, I have a thought about the Irish bailout. Two thoughts, actually–the second being that I wouldn’t bet heavily on my first thought. The short version (skip the remaining paragraphs of this post if you don’t want the rationale): I continue to think the most important factor for an equity investor in Europe is that economic growth there next year will be at the bottom of the list among the areas that you can reasonably think about investing in. That means the ride may be bumpy, but you should look for stocks whose headquarters are in Europe but whose actual operations are elsewhere–including the United States. My guess is that current questions about possible default on sovereign debt will, in the end, prove to be irrelevant to equity performance.

Why?

To me the speculators who are betting against the euro (that is, currency and bond traders in the big global commercial banks + hedge funds) are using the playbook they developed in attacking smaller Asian economies thirteen or fourteen years ago. The idea back then was to attack the smallest and most vulnerable (Thailand) first, and use the profits from the this initial skirmish to roll up bigger targets until every country whose finances could be toppled was in fact pushed over the edge.

For a while, this strategy worked to perfection, until the speculators decided to try to break the peg of the HK$ to the US$. What they failed to realize was that for Hong Kong, and Beijing as well, this was a political, not an economic, issue. For Hong Kong the peg was the paramount assurance to entrepreneurs that they could keep their fortunes in Hong Kong without fear that it might be confiscated by a change in the rate or some other adverse political decision. For Beijing, consumed at that time at least, with reunification with Taiwan, Hong Kong was the showpiece that would communicate that life in the People’s Republic would be pretty sweet. Both the SAR and Beijing took very decisive action to defend the HK$ against a speculative attack that had by that time gotten up a considerable head of steam from its success elsewhere.

So, á là emerging Asia, the plan for Europe is to steamroll Greece, then Ireland, then Portugal, then Spain, then Italy, then France… At some point, EU governments will work out that the result of these speculative attacks, if not their intention, is the end of the euro. Then the issue ceases to be a narrowly economic one and becomes political. Policy action shifts from trying to kick the can further down the road to stopping the speculation entirely.

I think we’ve got to be close to that inflection point now. After all, it; not exactly rocket science, and we have seen this happen in the recent past. The two open questions are whether policymakers want to hold the euro together and whether they have the monetary firepower to do so. I think the answer to both questions is yes. If that’s correct, then companies with large Asia and Americas exposure will probably do quite well. If not, well…go back to look at what happened in places like Thailand and Korea.

September 24, 2010

Here we go again. In the ziz-zag sideways or slightly rising course the S&P 500 has been tracing out over the past several months, the index seems to have just completed one leg of its journey and is tacking back in the other direction.

During the past month or so, the S&P seems to me to have reconfirmed a base around 1050 and then launched itself upward toward 1150. The good news is that it quickly broke through the 1100 level and has stayed considerably higher than that for weeks. But, having noted 1150 as a possible new area of resistance to advance, short-term traders are again probing to see how far back down the index can be pushed.

To my mind, it will be another small victory for the bulls if the S&P can hold above 1100. That’s especially so since we are in a time that is normally seasonally weak (my guess has been that “normal” heated selling by mutual funds squaring their tax books won’t happen this year, since most have deep accumulated tax losses and therefore can’t do anything to affect the size of the net recognized gains (none) they have to distribute to shareholders).

Although I view the short-term market action as being driven predominantly by traders “reading” charts, there are two fundamental factors that I think will provide some underpinning for Wall Street.

–US corporations continue to report earnings at or above expectations. They paint a picture of a US economy advancing slowly on its own steam, while getting considerable assistance from booming emerging markets.

–The dollar has weakened by about 10% since June against both the euro and the yen. If you think, as I do, that companies like XOM, APPL, or IBM have a long-term intrinsic worth, then a 10% decline in the value of the currency in which their shares are denominated should be matched by a similar rise in the stock’s nominal value in that currency. In other words, a 10% fall in the dollar should sooner or later mean a corresponding rise in the index.

All this makes me speculate that 1100 is the new floor for the S&P. The next couple of weeks should tell for sure.

September 9, 2010

Market action during September and October is usually heavily influenced by end of year housekeeping by mutual funds. That normally means selling pressure that begins in mid-September end ends in mid-October, as the funds, whose fiscal years almost invariably end on Halloween, adjust the size of their annual distribution of income + realized gains to shareholders. ( See my post on this topic.)

My guess is that the industry as a whole has such large realized losses–for a lot of reasons, but mostly from selling to meet redemptions at the market bottom–that fund will have no chance of using them up. Therefore, they won’t be able to make capital gains distributions at all. If I’m right, downward pressure on the S&P from mutual fund selling aimed at changing the size of the distribution will be a non-factor this year.

Looking at what happened this time last year doesn’t give much help. Yes, there was some weakness at the end of September and again at the end of October, but the latter selling comes too late in the month to be mutual fund activity (auditors usually ask mutual fund managers not to trade on the last few days of the year, if they can, so it will be easier to close the books). To me, last year’s September-October movements look like the same kind of short-term probing of the top and bottom of the market’s trading range that we’re seeing in S&P activity currently.

As I’ve been writing for a while, at some point investors’ thoughts switch from considering profits in the current year to begin to discount the next year’s prospects. In a healthy market, this shift in focus starts around July. So far this year, I haven’t seen it happen–which means one of two things:

–the shift is still to occur and will give at least some upward bias to the index, or

–it has happened already and I’ve missed it. Since there’s been no appreciable change in the S&P over the summer, the market would be saying it expects no noticeable increase in economic activity or corporate profits in 2011. I think that view is much too pessimistic.

I think a reasonable expectation for next year is S&P profit growth of 10%. If so, the difference between my two cases is one of timing, whether the market begins to discount this prospect soon, or whether corporate profit reports only force the market to advance as they are released. In this respect, I think the tone of the post-vacation market, whether it be a move upward toward 1200 or more meandering around current levels, will be set in the next week or two.

Whether mutual fund yearend selling intervenes or not, my bottom line expectation is that stock start moving up again before December.

August 29, 2010

August is a very peculiar month on the investor’s calendar. No, this isn’t the start of a Mark Twain or Will Rogers joke. Europe more or less shuts down for the month and goes on vacation. Wall Street minds and bodies turn to the beaches of the Hamptons. And, though Tokyo has become a non-factor in today’s equity world, that market is caught up in the Obon festival and for a time glued to tv screens during the national high school baseball tournament. The result is thin volumes and a sense of marking time until the heavy hitters return to work in early September.

August has seen two significant developments this year, one of them technical, the other fundamental. There has been some market reaction to both, but it’s unclear whether either have been already fully discounted or whether the full market impact will come only after the senior managers have returned to the office and absorbed the news.

On the technical front, the S&P has shown again that the territory above 1100 is more an aspirational goal than a waypoint en route to loftier territory above. After spending the first week of August above that level, the index has turned south again. It seems to have settled around the 1050 mark that it touched before–and where similar declines halted–in February, May and June. Is this the floor, or is the next stop the lows of July around 1020? For long-term investors, a drop of 3% shouldn’t make much difference. For a trader, however, it’s the important question of whether to remain defensive for the time being or become aggressive again. We may not have clear evidence until after Labor Day.

The second development, the fundamental one, is more complex. Reports from air and sea transport companies over the last six or eight weeks indicate that world trade is booming. The latest reports, coinciding with stellar earnings announcements from international shippers, have this industry apologizing to customers for underestimating demand and quickly taking ships out of mothballs to meet their clients’ needs. In the US, however, overall economic growth is slowing. Unemployment figures are beginning to show significant layoffs of state and local government workers, as those bodies–many with legal mandates forbidding their running fiscal deficits–try to balance their books. And the back-to-school shopping season, almost over now, has been very slow. PC manufacturers and retailers are reporting that business is falling sharply from a year ago. INTC just revised down revenue guidance for its September quarter, given only on July 13th, by about 6% because of “weaker than expected demand for consumer PCs in mature markets” –(corporate demand and developing markets are both fine; trading in INTC was halted for the announcement, and the stock went up on the news).

The data seem to suggest that the US, the epicenter of the financial crisis, is going to lag the rest of the world in recovery. No surprise here. But although in the past global investors have tended to underestimate the resiliency of the US economy, this time it looks like pessimistic assessments will prove closer to the mark. This is certainly not bullish news. It suggests that the current period of high domestic unemployment and low GDP growth will continue for longer than the consensus expects. As Minneapolis Fed president Kocherlakota recently said, money policy in the US is loose enough that the unemployment rate should be 6.5%, not three percentage points higher. Job availability is up 20% over the past year. The issue is with the mismatch between employer needs and candidate skills. As Mr. Kocherlakota put it, “the Fed does not have the means to transform construction workers into manufacturing workers.” Therefore, “unemployment will remain above 8% into 2012.”

Less than a decade ago, US output, measured on purchasing power parity rules, was a third of the global total. Despite having risen since, the US represents only about a sixth today. In my experience, local equity investors in smaller-country stock markets have long since been able to make two crucial distinctions: between companies that depend on the progress of the local economy and those that rise and fall with the rest of the world; and between the health of the parts of the local economy that have representation in the domestic equity market and those that do not.

Half the revenues of the S&P come from abroad. Maybe half the domestic part serves corporations, whose federal tax payments are running at double the pace of a year ago. Half serves the consumer, who in the aggregate is little better off economically–though perhaps less frightened–than a year ago. One could also parse the consumer sector further, into companies that service the overall economy (like food companies) and those that cater to the 90% of Americans who are working (like department stores or specialty retailers). But you get the idea. there’s no obvious reason, other than that Americans have traditionally done it, to strongly link the well-being of the local equity market to the health of the economy. True with government bond, but not with stocks. If the local economy is week, small-market investors simply reorient their portfolios toward securities that benefit from the more promising international arena. But to make this distinction, you first have to realize that your country is no longer the dominant factor in the world economy.

We’ll see how far along this path Wall Street’s big guns are when “serious” trading resumes in a week or two.

July 28, 2010

The S&P has rallied back above 100 and just about, but not quite, to the previous short-term high water mark reached on June 21. The June numbers featured an intraday high of 1130 and a closing high of 1117. So far in July, we’ve reached 1120 and 1115.

Again we’re at a critical near-term point, I think, in two respects: will we be able to establish new high ground above the June figures? will be able to stay above 1100 on the S&P 500? If so, the next target is 1150 (January 2010) and then 1170 (May 2010). If not, traders will shift their focus to trying to find a floor for the market. That is likely to be reconfirmed at either 1050 or just above 1000.

I’ve got no strong ideas on which is more likely to happen. Either way, I think we’re reestablishing a market trading range with a mild upward bias.

The current upswing breaks the pattern of prior advances, in which economically sensitive stocks have led and defensives have lagged badly. This time, all industry groups, save healthcare, have been rising strongly–even telecom and utilities. I take this as a sign of a change in attitude by investors–expressing the conviction that stocks as a whole are too cheap at 1020, as opposed to the belief that a robust domestic economic recovery is going to break out any time soon.

I see two concrete reasons to feel good about stocks, and one to feel, maybe, not so good.

On the positive side, corporate results during this quarterly reporting season continue to be stronger than analysts’ expectations, despite the domestic macroeconomic news that portray an economy that’s just limping along. Sooner or later, investors will begin to connect the dots (I think it’s happening now–but I’m the eternal optimist) and realize that the US is the caboose of this global upturn and that the fact that the numbers are coming from an industrial orientation and international exposure doesn’t make them less real.

Also, the year is more than half over. Given that Wall Street is a futures market, at some point stocks have to turn their attention to 2011 prospects. I think next year will be when the domestic consumer resurfaces as a potent economic force–not because more people will be working, but because the people who are working now will have gotten raises for the first time in years and will have more money to spend. Even without a resurgent mall-goer, S&P profits are likely to be up by around 10%, I think. That would suggest to me a yearend 2011 target (seventeen months from now) of 1350-1400 vs. maybe 1250 for 2010. 1100 will look a lot more attractive as an entry point to stocks as this shift in thinking happens.

The “bad” news? Individual investors have recently been showing a strong interest in buying corporate bonds. This is at least partly due, I think, to a shift in investment preferences by aging Baby Boomers from capital gains to current income. But individuals, who are generally much shrewder than professionals give them credit for, must realize that if an enterprise is foundering the difference in risk between bonds and stocks is akin to figuring which deck of the Titanic your room is on. The move to corporate bonds can (should?) be seen as a statement that individuals see the stock market as unfairly tilted toward the interests of investment banks by collusion between brokers and Washington. It’s sort of like having a biker gang taking over the street next to yours. For a while, at least, you’re probably going to avoid it. If so, the immense amount of individual cash on the sidelines may stay there for the present, despite ultra-low fixed income yields.

July 11, 2010

I spoke too soon several weeks ago when I wrote that I thought 1040-1050 on the S&P 500 would be the near-term low.

No sooner did the index bounce off that level and crack back through the 1100 line–which I, if no one else, consider important–than it reversed course and dropped down to reach 1010 (intraday) five trading sessions ago.

A holiday-shortened week later, we’re at 1078. Saying you’d have to pay for a roller coaster ride like this at an amusement park doesn’t add anything to the discussion (I like the thought, though). But the volatility is astounding, and presumably it isn’t going to go away immediately.

Remember, the world economy hasn’t gotten 8% worse and then suddenly 7% better, all within three weeks. So the reason for this violent stock market movement must be something else. Long-term investor attitudes normally don’t change this quickly, either. By default, what we’re left with is the behavior of shorter-term traders, who are constantly trying to figure out an entry point where they feel confident that buying will yield profits over the next three to six months.

I had thought traders had concluded that point was 1040. But they seem to have changed their minds. Now 1000+ seems more like it. That’s right above the point to which the market plunged in the wake of the Lehman collapse. It’s also the area where the market made its first, and relatively lengthy, pause on the way up again after the mild correction of June-July 2009. So there’s lots of recent history of market struggle around this level.

If the world in general hasn’t changed very much over the past few weeks, what has that would motivate a more pessimistic assessment of the market?

The recent bout of weakness comes at about the same time as macroeconomic and company data appear to be confirming conclusively that a rapid, consumer-led recovery in the US is not on the cards. After a few strong months, private job formation has slowed to a sub-100,000 per month pace, for example. And consumer spending has been lackluster. The latter should not have come as any surprise. Veteran analysts of consumer behavior have been saying pretty consistently that Americans have been willing to trade up from WMT and TGT to JCP and M, but don’t yet have the confidence to return to the (more expensive) stores in the malls.

Wall Street, with a cliché for all occasions, might point out, however, that nothing is ever completely discounted in advance. There’s always someone who only figures things out when an event actually occurs. Maybe these folks were the sellers of two weeks ago.

Where to from here? My basic stance from June 17th hasn’t changed. I think we’re still in a bull market and will be for a considerable time to come. I think we’ve been trying over the past couple of months to determine a market floor where investors will feel comfortable buying stock. Volatility has been greater than I’ve anticipated, but I think we continue to meander along with a mild upward bias as buyers build up their courage.

June 17, 2010

Have we turned the corner?

As far as the correction we’ve been in since May, yes. I think we’ve seen the bottom and have bounced off it. If I’m right, this means we have a relatively stable platform in terms of market level from which to look for attractive stocks.

It would be nice if the market were to continue to rise from here. But I don’t think that’s necessary in order to be able to make money in stocks–it’s sufficient if the bottom doesn’t fall out of the market again for a while. In fact, if I had to guess, I’d say the S&P will do little more than meander along for a while, with a slight upward bias. What could change that? better than expected earnings, or an investor shift to begin discounting 2011 corporate profits.

anticipation vs. reality

You can divide a stock market cycle in any number of ways in order to analyze it, but one useful distinction, at the present at least, is that between the market’s initial upward move off the recession-induced bottom in anticipation of future recovery, and a later, further upward move driven by earnings gains that the actual recovery produces.

It seems to me that the anticipation phase ended some time earlier in the year–maybe when the S&P broke above 1250–and that we’re in the earliest stage of the earnings-driven phase of the bull market.

the correction

Over the past six weeks or so, the market has been factoring into prices the negative side of structural financial problems with the European Union. Investors, who knew intellectually that the economic rebound in developing economies would be on the aenemic side, also began to have second thoughts about stocks when macroeconomic indicators and corporate results began to indicate as much.

More recently, and from lower market levels, the S&P has begun to discount the other side of the coin–namely, that the euro’s decline will boost the EU’s near-term growth prospects, and that Treasury bonds have again become the only game in town for trade-surplus countries wanting to invest their cash. So fears that Beijing will cut off credit to Washington any time soon are groundless. Two things suggest to me that the market has turned the page on economic worries for the moment: the recent downgrade of Greek government debt barely elicited a yawn from Wall Street; and the S&P has driven through the important 1100 barrier without much trouble at all.

what we’ve learned

Looked at from a different point of view, and just reflecting on the action of the S&P 500, we’ve learned that at 1200 or so investors no longer want to bid up overall stock prices. Why?–because even if we assume an exit point for the index in December of 1300, the returns are less than 10%, not enough to compensate for the risk of owning stocks.

Given the troubles with sovereign debt in Europe and the apparent slowdown in employment gains in the US, a drop to 1100, implying gains this year of 15% or so–which had been enough to bring buyers back to the table earlier in the year, showed itself to be inadequate to entice money from the sidelines this time around.

We hae learned something new, however. The point where buyers reemerge is now about 1060, or a demand for about an extra four percentage points in return for taking the risk of holding stocks.

In summary, I think the “all clear” has sounded for the market and it’s (relatively) safe to buy again. My favorites still include Europe-based multinationals, emerging markets and secular growth stocks.

June 7, 201

reading the charts

Time to break out the ouija board again. Maybe the darts instead, for a change of pace.

We’re back down at the 1050-1069 level on the S&P 500. Not a novel experience, since we were back here last November, then again for a goodly amount of time in February, and briefly during the “crash of 2:45” (aka Flash Crash). The May Employment Situation Summary by the Labor Department delivered us back here once more last Friday.

Actually, that last sentence isn’t 100% fair. After all, the downdraft we’re currently in started out about the time last month’s surprisingly good employment report was released. Ignoring fundamentals for the time being, the charts seem to be saying several things:

–for the present, 1100 looks like a pretty firm ceiling on any market advance,

–we’re now feeling around for where the floor for the market will be. If we’re lucky, it will be right around here, but

–the rules of the trading game have changed recently. The market is no longer powering ahead relentlessly, with only short stops for breath. This correction has already lasted longer and gone deeper than its predecessors. So it’s harder to predict what will happen over the next month or two.

the sensible solution

A Giant, Dodger and Yankee, “Wee” Willie Keeler played major-league baseball for 19 years, mostly in New York, despite being 5’4″ tall and weighing only 140 lb. Nevertheless, he had eight consecutive seasons with 200 hits or more. His batting philosophy was simple: “Hit it where they ain’t.”

My answer to the question of where the market is headed over the short term is a similar statement of the obvious: I don’t know. Therefore, as fun as calling each twist and turn of the market may be, I’ve got to have an investment stance where these movements will make as little difference as possible.

Of course, any serious investor is going to have a multi-year investment horizon, so short-term volatility shouldn’t be a big issue in any event. But sometimes you can lose your bearings in the heat of the moment. Besides, a time like this is also a good occasion for re-examining major assumptions and either overhauling or fine-tuning what you’re doing.

For what it’s worth, here’ what I think:

–we’re still in a bull market

–economic progress will be industry first, consumer second, the reverse of the way the US usually recovers–so the May employment report doesn’t particularly surprise me. Clearly, though, mine is still a non-consensus view.

–pay close attention to how much risk you want your holdings to have. If you’re have as much as you should already, do nothing. You shouldn’t exceed your normal risk tolerances just because the stocks you like look cheap. If you have less, a time like this is a chance to sell defensives and reorient toward economically sensitive stocks.

Monday trading on Wall Street will be interesting to watch (I’m writing this on Sunday after the Tokyo opening). If one thinks that the S&P can be at 1250 by yearend and that a 20% gain is enough to justify buying–both of which strike me as reasonable assumptions, then arithmetic says the market should stabilize around 1040. For the moment, that may prove to be too optimistic. On the other hand, at some point the market will begin to factor into today’s prices profit developments it thinks will take place in 2011.

In a market feeling optimistic, the transition would start next month. For that to happen, though, Wall Street will likely have to shake off its current negative mood. I think a reasonable general target for next year’s close would be up 10% from this year. If that’s close to being correct, then within the next few months investors will begin to measure potential upside from last Friday’s level as being 30%, not 20%. When that occurs, the measurement of the chance of potential loss vs. the chance of potential gain will tilt further in favor in the bulls’ direction.

May 19, 2010

Let’s begin by looking at what has changed over the past few months:

1. What really jumps out to me is how much the euro has fallen, from being worth about $1.50 late last November to going for $1.22 now. That’s a 19% drop.

The reason, of course, is the financial crisis in Greece, which came to a head at the same time that the euro began its swoon. Greece’s dilemma has shone a spotlight on a well-known structural defect in the European Union—that Brussels has no effective control over the government spending of any member countries.

Looked at from a slightly different angle, the situation between the largest (only?) creditor nation in the EU, Germany, and Greece looks a lot like the relationship between China and the US—with the US playing the role of Greece. The common currency, the euro, is the equivalent of the peg China has established between the renminbi and the dollar. The point being that in each case both sides have gotten something they wanted out of the arrangement.

Unlike China-US, Germany-Greece are parts of the same political body. So the solution to their problem will likely come, over time, as a political outcome—more power to Brussels, less to member countries—rather than a strictly economic one.

Yes, the need to trim government borrowings will slow economic growth. But the OECD estimates that the decline in the euro will add 2 percentage points to EU growth next year. Two consequences: buy European stocks, especially those with operations in stronger-currency areas (think: US or emerging markets); also, shy away from US stocks with large European exposure.

2. The Shanghai stock market has fallen by 20% since early January. Most of the decline has come over the past month.

Some commentators have pointed to this as a harbinger of upcoming weakness in the Chinese economy, which will soon emanate into the rest of the world. I’m not so sure. If there were a long history of correlation, or if Shanghai were open to foreigners, or if China had a fully functioning bond market as a savings alternative for locals, I might take the decline in Shanghai more seriously. To me, the most interesting aspect of the drop is the much closer price relationship between shares dually traded there and in Hong Kong. I doubt the two will be linked anytime soon, though.

I’d be tempted to look at Hong Kong-traded stocks like Wynn Macau (I own it) and Sands China, but neither has weakened so far.

3. US economic indicators are by and large coming in much stronger than had been expected. It now appears, for example, that the domestic economy has been adding jobs for the past several months.

The earnings picture for publicly traded companies in the US is complicated, though. Firms have by and large been reporting very strong results. But they have been giving lukewarm guidance, especially for US operations that serve the consumer, for the next quarter. And despite the profits surge, there has been little positive movement in the share prices on the earnings announcements.

Why is this?

–For one thing, the announcements of results are coming during the one-step-back state of the market’s normal two-steps-forward… rhythm.

–Brokerage house analysts have doubtless realized that their forecasts have been woefully low for several quarters and added something “extra” to their estimates this time around—the consequence being that the reported numbers are no longer so surprisingly good.

–As everyone should know, although better than forecast, the current recovery isn’t particularly strong so far. This means there’s not enough economic energy around to make every company as star.

–Also (although this may be the dead horse that I’m flogging), the market has been acting up until now as if the current recovery will be a conventional US one—that is, the consumer picks up first, then industry. I’ve been arguing that the opposite will occur—industry first, consumer later. I think corporate results are beginning to bear me out, but the market is misreading this as a disappointment to investors who have been expecting a repeat of past experience.

What to do? stick to the strongest companies in an industry, look for emerging markets exposure, and shade toward technology, away from retail, especially apparel.

May 18, 2010

charting voodoo (no offense to voodoo practitioners intended)

How should we assess the current market situation? There are three (simple-minded, though usually effective) indicators we can look at to compare this correction with previous ones.

First, though, we have to ask ourselves the more basic question–are we still in an uptrending market, or are we in the process of making a fundamental change in market direction? Again, simple as it seems, the answer to this question is the most crucial in determining one’s tactical (and strategic) stance toward stocks.

It seems to me that we’re just beginning to see signs now of an economic recovery that will likely last for a couple of more years. We’re also only about a year past the very worst. So I think it’s way too soon to be seriously concerned with a reversal of direction and that what we’re in now is a correction in an ongoing bull market.

Having said that, here are my indicators:

1. how long? The current correction has gone on for 16 sessions. The correction of June-July 2009 lasted about 20 (the number depends on whether you count from the peak, which was followed by a few flat days, or the first day of decline. In practical terms, it makes no difference). The correction of January-february went for 14. So in terms of duration, recent history suggests we’re close to the end.

2. how deep? The current decline has been about 7% from the recent highs, if you don’t include the “crash of 2:45” two weeks ago. The drop is 13% if you do. This compares with a 9% fall last June-July and a similar decline in January-February. Again, in terms of extent, this correction seems to have done about as much damage as the previous two.

3. connect-the-dots. If you pull up a chart of the S&P 500 and mentally draw a line (or you can put a straight piece of paper on the screen) that connects the high of last June with the bottom in February, you get a line that also hits, or moves slightly below, the bottoms of all the smaller corrections we’ve had along the way. If you extend this line to the present, it would be at about 1130.

If you think that the S&P is moving gradually higher in a tunnel or “channel” where it bounces up when it hits the lower wall and drops back down when it hits the upper wall–and I think this is a reasonable description–we’ve just drawn the lower wall.

I’ve always had more trouble drawing the upper side. It should be parallel to the lower line. To my mind, it rests on the tops the market made last October and November. That would imply that the S&P dances on the roof (outside the channel) in January and in April, but that doesn’t bother me. If you extend the upper line to the present, it reads something about 1200.

So…if the picture we’ve drawn is in fact a rough sketch of the id of the market, and if we’re still operating in business-as-usual mode, then we’d conclude that:

–the correction is just about over

–we may have seen the lows already, and

–we have to go back to the drawing board if the market cracks much below 1130.

Tomorrow, a discussion of how the fundamentals have changed and what I think this means.

May 7, 2010

Yesterday afternoon, in a period of about 6 minutes, the S&P 500 dropped by 56 points, or about 5%. It then reversed itself and regained all the ground it had lost–although the index was down from the day. Reading the market commentary from NASDAQ-OXM wouldn’t give you a hint that anything unusual had taken place. This is no real surprise, since it wants people to think of the market as orderly. But the exchange has announced that it is canceling a bunch of trades that happened during the meltdown yesterday, across a large number of stocks. Here’s the list of the names affected.

Weakness flowed from the US into Asia and, at this writing, has continued into trading in Europe.

What happened?

Naturally someone, whoever started the snowball rolling downhill, knows. But no one is saying. What seems clear is that the precipitous drop was caused one or more by computer-driven sell programs. Either because the numbers input were mistakenly entered at 1000 times their intended value, and therefore the offending computer blew through all the stock being bid for by market makers, or because the market makers’ computers executed a defensive maneuver we haven’t seen before and simply stopped offering to buy stock, the market dropped like a stone as the machine continued to search for buyers at ever lower levels.

Stuff like this has happened in other markets on occasion in recent years. A trader accidentally enters orders that are magnitudes larger than intended, internal systems don’t catch it and–KABOOM–temporary market havoc ensues. But even though in world terms the US is somewhat of a backwater in equity exchange technology, this sort of thing hasn’t happened on this scale here before.

What to make of yesterday?

1. One thing it isn’t,in my opinion. Downward market movements, from bear markets to the kind of bull market correction we’re in now, sometimes end when a potent mix of panic selling and forced margin liquidation cause a noticeable spike down in prices, usually on high volume. This acts as a sort of catharsis that releases the market’s pent-up fears, and also puts margin players out of their misery.

That’s what yesterday’s chart looks like. But, as scared as they might have been on the sidelines, it doesn’t appear that humans–other than the computer programmers and the guy who pushed the fateful button that triggered this, were involved at all. Accenture, for example, reportedly dropped from $40 to $.01 between 2:47 and 2:48. Nobody is that crazy. This was a computer.

My point is that there was no catharsis, no purging of irrational fears yesterday. I think the correction, which will probably end with a whimper rather than another bang, still has farther to run.

2. The tactic by market makers of temporarily withdrawing from the market as they see an oncoming train approaching, and simply letting the market drop, is common in smaller markets, especially in Asia. Seeing it employed for the first time is heart-stopping, but it soon becomes just another fact of life, not a portent of doom, and you get used to it. To my mind, outrage shouldn’t be directed at the purported “fat-fingered” trader who pushed the wrong button, but toward the exchanges that are unilaterally canceling trades made by buyers astute enough to realize what was happening.

3. Follow through today on Wall Street will be important to watch, for two reasons:

–at the lows yesterday, the S&P touched 1065, which is right around the intraday bottom of 1065 established in February. The close is right at the pre-correction highs established in January. It will be important technically, I think, for the market to stay above this level. Remember, too, that people tend to cling to the charts most tightly when they’re frightened.

–there was wider separation among stocks in after-market trading yesterday. Significant differences in strength are also evident in pre-open trading this morning. Sometimes shocks jar investors into rearranging their portfolios–dumping stocks they think will be losers and adding to those they have the strongest conviction in. Watching relative winners and losers today will likely give a good window into the current plans of Wall Street professionals.

An addendum: I don’t think this has much to do about Greece or the EU. Yes, the EU has problems and is under attack in its currency and bond markets. GDP could be 1% lower than it would otherwise have been. This will negatively affect the profits of US companies. But there are significant positive domestic offsets. April unemployment numbers are the latest example.

This is mostly human emotion (fear, in this case) playing itseslf out in stock prices.

May 5, 2010

a new phase to the bull market

It seems to me we’re entering a new phase of the market. Yes, it’s still a bull market, in my opinion, but we’re finished with the initial rapid, liftoff stage of the advance.

As I see things, when the market first turns from a downward trajectory to an upward one, several factors cause this to happen:

–valuation. Stocks are cheap. In March of 2009, for example, the dividend yield on stocks was higher in many global stock markets, including the US, than the interest yield on government bonds. This situation has only occurred rarely over the last fifty years, always at market bottoms, and most bear markets didn’t get that bad.

–deep pessimism/fear. Not just about economic prospects. There’s usually the fear that governments will be unwilling or unable to make an effective policy response. Usually, the latter worry stems from governments’ seeming inaction. In the US this time around, if you recall, Republican party legislators were proclaiming loudly that a rerun of the Great Depression of the Thirties was a better alternative than a bank bailout bill. Pretty scary stuff, ad the reason the S&P lurched down in March (also a vivid demonstration of how mercurial congress is and how poorly-equipped it is to be running the economic show–a negative that both domestic and foreign investors are surely now factoring into their buy/sell decisions).

–some action that signals bearishness has gone too far. True, valuation is a strong signal. But almost always that’s not enough, even for professionals. A change from restrictive to accommodative money policy, or a signal from the money authority that policy is about to change, is the typical sign in an inventory cycle recession. Last year, it was passage of the bank bailout bill.

In the first phase of a bull market, almost everything goes up. Company and industry fundamentals make some difference. But a lot of the power of the upward movement comes from repricing risk–a shift away from valuing securities based on the worst that can happen to pricing them on more optimistic assumptions.

Companies that had been left for dead on Wall Street’s trash heap recover spectacularly. Why? One example: The ultimate embarrassment for any equity portfolio manager is to be caught holding the stock of a company when it enters bankruptcy. They think (correctly) it reflects badly on their analytic skills. They also think it can get them fired. So most professionals won’t touch risky companies in a down market. As the market turns up, these fears recede and the low valuation starts to scream, “Buy me!”

In any event, I think phase one is over. We’re now entering phase two. What happens now?

In phase one, investors realize stocks are going up and increase their equity allocation, ditching cash and, if applicable, government bonds. They’re quick to buy stocks and slow to sell. Virtually any stock is better than cash and better than any bonds except junk.

In phase two, stocks continue to go up, but at a slower pace.investors . The market also begins to separate winners from losers within industry groups. So investors begin to prune their portfolios, paying increasing attention to distinguishing the wheat from the chaff.

In today’s market, I think the performance differential between industry leaders and also-rans will be especially sharp. That’s because this recovery is much weaker than would be the case in the bounceback from an inventory-cycle recession. The US economy is now growing at around a 3% real rate. That’s better than nothing, but its a far cry from the 4%, 5%, 6% real growth rate that would be common in the rebound from a garden-variety recession. Why does this matter? In contrast to more vigorous recoveries, now I don’t think there’s not enough business to go around to power big profit growth for second-tier firms. No one has to buy a Toshiba TV because Samsungs and Panasonics are out of stock. No one has to buy a Zune because Apple has run out of iPods.

All this suggests that individual stock selection will be a more powerful performance generating tool than sector selection. If that’s correct, a reasonable thing to do in the current choppy water is to use price swings to upgrade your holdings.

January redux?

Another issue that Wall Street faces at present is that in the first four months of 2010 we’ve already made all the gains brokerage house strategists had forecast for the full year. So what do we do?

We were in very close to the same situation in January, when the S&P hit 1150 vs. a yearend consensus target of 1250. That left less than 10% to go for during the rest of 2010. The market promptly corrected by 7% (9% from intraday high to intraday low), at which time investors judged there was enough near-term upside to begin buying again.

Three possibilities for today, as I see it:

1. We correct again. I think this is the most likely alternative. If so, this time will probably not be as bad as the last, since there’s more evidence now that the economic recovery is becoming self-sustaining. Also, I hear and read more stories that many retail investors are regretting their decision not to reenter the stock market last year and buy high-grade bonds instead, and are presumably looking for an excuse to buy stocks.

2. Strategists raise their targets and people believe them. The argument for doing so would be higher full-year profit estimates, based on better-than-expected March quarter earnings reports and a more bullish tone to company guidance. I think targets will rise. But I think investors will ignore the higher numbers for a while, figuring this is the kind of thing strategists always do–and thus has no significance.

3. In a “normal” market, Wall Street begins to factor into stock prices conclusions about what earnings will be next year in June or July. That reassessment, which would probably imply a price target for the S&P of, say, 1450, might come early–meaning the market wouldn’t look so limited on the upside. If we had another year of recovery and higher stock prices under our belts, maybe this might happen. Not now, though.

technically

At around 1200, we recently hit the lower end of the band the S&P was trading in during September 2008, the month Lehman went under. This is a significant milestone. From the point of view of the ebb and flow of short-term trading, the big question is whether the market can establish a base of support here, as we did a couple of months ago at the 1100 mark. If we do, the next target, I think, would be the top of the Lehman band at around 1300. Let’s see where the market settles out before thinking about that, however.

April 5, 2010

As I mentioned in Keeping Score yesterday, we’ve entered year two of the current bull market. Until now, it has been more important to figure out how bullish to be and how to position oneself to benefit from rising prices than to worry about when the party might end. Given that we’re clearly past the opening salvos of the up market, it makes more sense to at least ask the question of how soon we might need to become more defensive.

How long will the bull market last?

My conclusion is that, although the upward trajectory of prices may not be as steep in the next twelve months as it has been over the past year, the bull market has a lot longer in time to run. It is necessary to continue to ask the question of how long the good times will last, but I don’t think it’s anywhere neat time yet to act on worries of a major market downturn.

How so?

Typical signs of a top–I don’t see them

1. In my post of April 1, I provide some data on what has happened over the past twenty-five years as an economic rebound becomes strong enough the Fed thinks it can raise short-term interest rates back to normal levels. My conclusion: absent severe market overvaluation or large imbalances among stocks and bonds, the US stock market doesn’t peak until after the Fed is finished.

Normalization of short rates typically requires 200 basis points of increases–eight .25% moves–over two or more years. In today’s market we’re talking about starting the process but have not yet begun.

2. Look at the anatomy of a typical four-year inventory-driven business cycle, which corresponds with a typical stock market cyclical rise and fall. Stocks typically rise for 30 of the 48 months, make a high that exceeds that of the previous cycle, and then flatten and fall for the remaining 18 months.

What usually starts the down portion of the cycle is a Fed interest rate hike that is intended to slow an economy that is expanding too quickly.

We’re not dealing with a “normal” inventory cycle situation now. My point in mentioning it is to illustrate how long it takes–two and a half years–for the US economy to shift gears from slowdown, through recovery, expansion and on to the first signs of overheating. Arguably, the process will take longer this time around, since the economy is coming from a lower base. Again, it seems much too soon to anticipate the end to economic growth and a cyclical slowdown.

3. Psychologically, a bull market ends when

–taxi drivers are giving stock tips,

–subway riders are glued to the financial pages or

–strangers on busses are looking up stock quotes for each other,

–Wall Street gains come up in dinner party conversation or

–on line to get takeout from the barbeque pit.

I don’t see any of this happening yet, either. Quite the opposite. Retail investors still seem to be licking their wounds and staying in a defensive posture.

4. Bull markets also typically end when valuations are high and people are straining to make up reasons why they will stay in the stratosphere, or rise even further. I don’t think that’s the case now.

In the 1940s and 1950s, investors in the US appear to have thought of stocks as a funny, risky sort of bond. They seem to have seen stocks and bonds to be in equilibrium when the dividend yield on stocks equaled the interest yield on bonds.

Over the last thirty years, the heyday of the Baby Boom as investors, the relationship has developed to one between the interest yield on bonds and the earning yield on stocks–earnings yield being a shareholder’s portion of the profits of a company, whether paid out in dividends or retained in the company to pay for expansion. It’s also the inverse of the price earnings ratio.

There’s no “right” relationship. This is a question of investor preferences and of what sorts of companies are publicly traded. It’s at least possible (I think it’s likely) that as the Baby Boom retires, its interests will turn away from capital appreciation to capital preservation. BB investors will then be willing to pay less for a unit of profits retained in a company than they have over the past several decades. But this process will likely take many years to make itself fully felt in the market.

The situation now? 10-year government bonds are trading at a yield of 3.87%. The 30-year is at about a 4.75% yield. This compares with the S&P 500 now trading at a 7.1% earnings yield (a 14 pe).

Let’s assume a rising fed funds rate pushes the 10-year to a 5% yield and the 30-year to a 6% yield (for what it’s worth, I think these yields are thinkable but too high). The earnings yield on the S&P would still be over 100 basis points, or almost a fifth, higher than the 30-year.

In other words, the S&P seems reasonably valued vs. bonds, even after considerable Fed tightening and assuming no earnings growth for the S&P beyond 2010. To me, this is enough to support a 10% rise in the S&P from today’s values both this year and next. You might reasonably counter that this is too aggressive (please avoid the word “crazy”). That may well be. But by the same token, I don’t think you can say the figures support the case for an imminent and sharp market decline.

Turning to the charts

The 1150 line that proved so troublesome for the S&P in January–the index stayed there only a short while before dropping sharply–has provided almost no resistance on the way back up in February-March. The S&P seems to have settled in a 1165-1175 range for the moment. Next stop on the way up would be 1200.

This is a lot better performance than I would have expected. What does it mean? Your guess is probably as good as mine. My working hypothesis is that traders are still operating off technicals. On the other hand, fundamental analysts finally have earnings growth numbers–better than that, earnings growth numbers powered by rising sales rather than just cost-cutting–to work with and are tossing the charts out the window along with the tarot cards and ouija boards.

I’d consider that to be a positive development for the market. We’ll know more as March-quarter corporate earnings reports start to be made in the coming weeks.

March 15, 2010

Here we are, two months after the S&P 500 made a recovery high of 1150 in mid-January, doing it again.

Last time, the market stayed at around this level for about ten trading days. Then, unable to break higher, it turned around fall to a trading low around 1050.

What’s changed since then? A number of things:

1. We have more evidence that the market establishing a trading range with a bottom around 1050 and a top around 1150. If this is so, traders will be basing their very short-term decisions on a very simple calculation. When the market is at 1050, the short-term downside is minimal and the upside is a bit less than 10%. At 1150, in contrast, the short-term upside is minimal and the downside is about 9%.

At the high end of the range, the trader’s strong inclination is to sell. At 1100, he’s indifferent. At 1050 he will buy aggressively–which probably means the market never quite gets back to that level.

There’s no guarantee this pattern will last for a set period of time. If we’re in the bull market I think we are, though, the eventual break in the pattern will be to the upside.

For the moment, though, there’s probably no rush to buy. Better prices, i.e. a slightly lower market, may present themselves in the next few weeks.

2. Two months have passed, during which the new macroeconomic and company-specific data that have emerged have been almost universally positive. This increases the likelihood that the bottom of the range will hold.

3. Market sentiment has improved. I think it’s particularly striking that a stock like DIS would react positively to an analyst’s prediction that earnings will get better late this year and into next. Remember, a (maybe the) key difference between bull and bear markets is whether investors are willing to factor future earnings into today’s prices.

Last Thanksgiving I wrote that there was a battle underway (between bulls and bears) for possession of the 1100 line on the S&P 500. For a while in late December – early January that the bulls had scored a decisive victory. For a short while, it looked as if a new line of support/resistance was forming around 1140 or so. Then the bottom fell out. This struggle may ultimately turn out to be like WWI trench warfare, with little net movement in either direction for some time.

the charts

If you look at this chart of the S&P, you can see the story of recent market action very clearly.

1. The market dropped to just above the lows made in the first days of November before reversing course.

2. The correction was bigger, both in time and in extent of the decline, than the two steps forward, one step backward pattern we’ve been experiencing since July.

3. It resembles much more closely the market action of mid-June to mid-July. The February rebound, however, looks much less vigorous than the July upturn.

4. If you want to play connect-the-dots, you can draw a line through recent lows and another one through recent highs. You’d do this mostly because it’s fun and it gives the illusion that you control the charts rather than the other way around. The idea, though, is to see if you can get a sense of the slope (the rate of change) of the market advance by finding two upward-sloping lines that act as ceiling and floor for market gyrations. Ideally, the two lines have about the same slope (if the ceiling isn’t rising as fast as the floor, there’s usually trouble ahead).

One of the beauties of charts is that you can make them say almost anything you want. I’d form an initial floor for the market by connecting June 23 and Feb 5. the corresponding ceiling would be June 10 and Jan 19. I’d also try a second channel using the lows of Oct 1 and Feb 5 with the highs of Oct 15 and Feb 5.

Personally, I think the first set of lines is too optimistic. If anything, the second is, too. I still believe strongly that we’re in a bull market. My question is about how fast we’re going to get past the 1150 level.

the fundamentals

Enough hocus-pocus. What about the fundamentals?

To me, the key factor that has changed over the past few weeks is the weakness of the euro vs. the dollar. The more I read about Greece, which I’d never paid much attention to, the clearer it is that, like Italy, Greece has been a perennial problem-child of the EU. Headlines aside, then, Greek problems are not new news to veteran European investors. In the end, I suspect that situation is not a replay of the Thailand, Malaysia… crisis of the late Nineties.

If that’s true, the main consequence is that American firms with euro exposure become somewhat less attractive stocks and EU companies with dollar exposure become more attractive. It’s probably still a good idea for American investors to look for global firms, just not ones whose main foreign exposure is in Europe.

Company earnings reports continue to show considerable strength. Earnings gains are starting to come from sales increases, rather than solely from expense control, as was the case six months ago. Notably, many managements are saying that they think the lowest point for them occurred in late summer or early fall of last year-and that business has been picking up since. Not every firm is a winner, however, even though overall corporate results are improving. Demand isn’t that good. Strong firms continue to take market share from their second- and third-rank brethren.

The consensus appears to be forming that S&P 500 earnings for 2010 will be around $85, meaning that the market is now on a 13x price earnings multiple of that number. I don’t see any reason why the multiple shouldn’t expand to 15, which would be consistent with a 6.5% yield on a long Treasury bond. And at some time during the year (the fall, maybe?), the market will begin to discount 2011 earnings, which will presumably be higher than 2010’s. This argues that there is still considerable upside left.

What’s holding the market back, then? Three things, in my opinion:

1. Corrections happen periodically, without necessarily any rhyme or reason.

2. When the market was at 1050, investors thought the potential upside to buying stocks was very compelling. At 1100 a couple of weeks later, the need to purchase isn’t so urgent. Only time will fix this problem.

3. The beginning of the process of “normalizing,” that is, raising, interest rates from their current emergency lows is still ahead of us. I think this will be unequivocally bad for bonds. Stocks, on the other hand, will be cushioned from the negative effects of higher rates by rising earnings. Ultimately, the rise in rates may have little effect on equity prices. That remains to be seen, however. And initially that may not be the case. For a while, stocks might fare just as poorly as bonds. The bullish rejoinder would be, “Yes, but that move could easily be a fall from 1350 to 1250 on the S&P.” For now, though, I think most investors find rate worries to be another reason to sit on their hands.

my conclusions

A sideways-moving market isn’t a bad thing. It gives you time to do research on potential investments without having to fear that they’ll run away from you before you’re finished. I still think we’ll end the year up 10% or more on the index.

Winners will likely be: leading firms in any industry, companies with foreign exposure (ex Europe), and those with predominantly under 50-somethings as their customers. I’m also struck by the large number of firms that are initiating or raising dividends. They’re likely to do well, too.

My list of relative losers contains: purely domestic firms, Baby Boom-centric companies and also-rans in their industries (although these will also comprise the bulk of the takeover candidates).

February 7, 2010

It may be that patriotism is the last refuge of a scoundrel, but for a fundamental analyst–that is, someone who believes that securities prices are ultimately determined by company/industry/country economic events–the true sign of despair is trying to read the charts. (By the way, there is one step lower than technical analysis–it’s the complete abandonment of hope (sanity?) and consequent recourse to CNBC for investment advice.)

I think no one really just “reads” the charts. Everyone has a context, a basic amount of economic information that he brings to the party. Everyone also has certain chart features that he thinks are important and others that, for him at least, make no sense.

In my case, I’m convinced there’s a strong psychological tendency for investors to buy and sell where there’s been lots of buying and selling before. For example, a holder who has sold at 20, only–to his regret–to see his stock rise to 30, will probably buy again if the stock falls back to 20. A buyer at 20 who has sold at 30 will probably be eager to try the trick again. Voilá! Support at 20, resistance at 30. The more past transactions there are at any level, the stronger that level is both as a floor and a ceiling.

To the details of the current market:

I’m sticking with my diagnosis of a week ago that world stock markets are in a correction during an ongoing bull market. If so, the questions of the day are how long will the correction last and how deep will it go.

On the second question, the charts are surprisingly easy to read. The S&P 500 struggled with the 1100 level through the second half of November and the early part of December before breaking through to the upside. It has since come back down through 1100 and 1070 with relative ease and is hovering around in the next lower level of buying and selling the 1040-1050 area. My guess, about which I have very little conviction, is that the selling stops here. If not, the next floor down on the elevator is around 1020.

The first question is harder to answer. Most down movements since last March have lasted about two weeks, with the deeper correction in June-July lasting four. The current episode has been going on for three. Arguably, then, we’re getting to the end in terms of time. There’s one wild card, for me anyway–whether we’ll see forced selling by hedge funds that produces an unexpectedly deep selling climax. My guess, again with little conviction, is no–or we might have seen it last Friday afternoon. Certainly, the skill level of the hedge funds we read about in the financial press is abysmally low. One would hope that most of these have been forced to close down, lessening the risk. But who knows?

February 1, 2010

An up day like this one, coming after a series of lower closes, can contain important information about the stocks you hold in your portfolio. This is especially true if you think, as I do, that the direction of the market this year is up.

Arguably a correction happens when prices have risen to a point where the reward of additional near-term appreciation is outweighed by the risk of near-term loss. Stocks then fall as short-term traders sell. Stocks “reset” at some point where risk/reward looks more favorable.

If that’s what is happening now–and I’m not sure it is–then economically sensitive stocks will be outperformers again. They certainly are in the US so far today.

What to do? Look at the stocks you own. If they’re bull market stocks, they should be up more than the market. If you have stocks that aren’t, that’s a reason to reevaluate–not necessarily to sell, but to reevaluate…because the market is saying it sees something different from what you do.

January 24, 2010

What an ugly three days!

On the other hand, the market never goes in one direction–especially the direction you want it to go in–without counter-trend movements. Declines are just a fact of life. What’s truly remarkable is that we haven’t had more of these episodes over the past nine months. If you look back at the chart of the S&P 500, the sailing has been unusually smooth since March. One speed bump in late June-early July is the only event that catches the eye.

Looking at what’s going on now, several things strike me.

1. We’ve moved back down through 1120 and back to the 1090 line that provided resistance during December like a knife cutting through butter. This suggests to me that short-term traders are stepping back, letting the market fall and waiting for the market to stabilize on its own before moving back in. This is standard fare for emerging markets but not as common in the US.

2. It’s not clear (it never is) that we’re done falling. The next stop, if we break below 1090, seems to me to be 1050.

3. Looking at the charts, there was no obvious stopping place after 1100 or so on the way up to 1200. Now there is–1150.

4. There’s no “right” reason for why the correction is happening. You could argue that investors are beginning to discount the Fed raising interest rates later this year. You could equally well say that traders had nursed their winners into 2010 for tax reasons and were waiting for the first sign of the market advance getting tired to jump in with both feet and sell.

What to do during this time? Most people just close their eyes and suffer. That’s a mistake. Look for trading opportunities. In a market phase like this, strong stocks that have gone up a lot tend to go down the most. Relative clunkers that haven’t gone up at all tend to retreat the least. A time like this is great for ditching any of the latter that you may own and buying, or adding to, the former.

January 17, 2010 a belated Happy New Year!!

I’m a little embarrassed that it has been this long since I’ve updated the Tactics section.

The S&P 500 spent the first half of December 2009 looking for a direction. The index remained more or less flat for almost three weeks, hovering just above the 1100 line. This is unusual behavior, defying the (very useful and almost always correct) cliché that the market either goes up or down and never marks time. I attributed this to investors just wanting the year to end and being happy not to rock the boat.

Looking back at the chart of the S&P 500 now, one can see that in the later half of December stocks began a steady move higher to about 1150, before stalling during the past week. Compared with market movements during the second half of last year, this advance had a more modest positive slope, but has been longer in duration.

I don’t see anything particularly significant about 1150 that would make it a temporary ceiling for the market. The S&P dropped like a stone from 1200 to 1000 in September-October 2009, so you have to go back to 2005 to find periods when investors spent any significant time between those two levels. I’m not sure that’s helpful.

But the market seems to me for now to have decided to come to a screeching halt at 1150. If so, we have to figure that it could retreat to 1120, which acted as a ceiling for the S&P in December. Trading over the next few days may give a better indication of the market’s near-term direction.

The sectoral pattern of the market’s performance also seems to be changing from the consistent outperformance of cyclical sectors that has marked the prior nine months.

So far in January, Materials and Industrials are winners, but so are Healthcare, Financials and Energy. True to past form, Telecom and Utilities are losers, but they’re joined by former plus-siders IT and Consumer Discretionary. I read this break from the pattern of last year as a typical counter-trend movement that will likely continue for a while. How long? I don’t know.

Friday the 15th of December

Last Friday was aan interesting, if losing, day. INTC was weak (down 3%), even though it reported a spectacular quarter after the close on Thursday–and despite a lot of other recent evidence that the economic recovery is strengthening and a significant IT upturn is under way. So, too, was JPM (down 2.3%), which also turned in very strong earnings, but opined that the US consumer is still not in good shape (this was a surprise?).

This may just be the action of investors who have nursed their winning stocks into the new year selling on the positive earnings news. Or it may be that after two gigantic steps forward, we’re due for a step back. There’s certainly every reason to continue to believe that the primary direction of the market is up.

INTC certainly seems to be a cheap stock to me. I’m not so sure about JPM, partly because I’m not so good on financials, partly because I worry that (justifiable) public anger about bankers’ large bonus payments will result in adverse regulatory changes. I’ll post on both topics in the next couple of days.

November 26, 2009 Happy Thanksgiving!

The struggle for 1100 on the S&P 500 index is underway

From its low of 1029 on November 2nd, the market rose pretty steadily until it hit an intraday high of 1114 on November 16th. Rather than immediately reversing course, as the market has done in prior months, it has more or less traded sideways since. The S&P has touched 1086 intraday, but it has spent most of its time the past eight trading days above 1100 and has closed above that level for six of the past eight trading days–and for the last three days in a row.

Is 1100 really so important? Maybe not. But it is the highest level the market reached in October and a place where it traded for several days before falling back. On the idea that resistance, once broken through, becomes support, it would be very positive if the market could stay up here. The longer the market stays here, the more it “tests” 100 without breaking significantly below, the stronger this presumed support level becomes.

What if we can’t stay here? The next important point below would be the jumping-off point for the current up movement, that is, 1029.

How about that dollar!!

The US currency is making another lurch downward this week, with the € selling for close to $1.52 and the $ buying only ¥87. While we’re still some distance away from the all-time high for the € of $1.60 (reached in April 2008), we are fast approaching a high level of the yen not seen since the Nineties. The weakness of the greenback against emerging market currencies, like the Brazilian real, is even more extreme.

When does the pummeling stop? Not any time soon. The dollar decline, and the associated massive loss of wealth to the chief pummelees–holders of US Treasury securities, both US and foreign–is part of the process of re-establishing economic equilibrium after the financial crisis.

One of two things will happen to stem the dollar decline: either the US will signal the start of a return to normalcy by beginning to raise short-term interest rates, or the dollar will reach a point that screams out that the value is too low. If that happens, it may be really low, however. The yen peaked at a level in the Nineties, for example, that implied that the US and Japanese economies were roughly equal in size (even though Japan had half the population, equal productive assets and at best equal productivity).

If what I’ve just said is true–and I think it’s as true as anything ever gets in financial markets– then the best stocks will continue to be those which benefit from the dollar decline and the worst will be those that look the most like Treasury bonds.

One oddity of today’s trading: every sector, ex staples and financials, did better than the market–yes, even utilities and healthcare. A harbinger? probably not, but still worth keeping an eye on. Especially so since I’ve barely finished posting the idea that the “loser” sectors wouldn’t get up off the floor for a long time yet.

November 10, 2009

It looks like the pattern of higher lows on the S&P 500, followed by higher highs, remains unbroken. The market reached an intraday low of 1029 on November 2nd the previous low had been 1019), before reversing course and heading upward again. The previous intraday high was 1097. We’re still a bit below that.

The speed at which the market is reaching for new high ground seems to me to be slowing a bit. I think that’s only natural, given the high velocity of the rise since July. All other things being equal, we should want the S&P to close above 1120 or so. At the risk of trying the fruitless task of describing the leaves on every single tree, this is the next short-term point to look for. But I don’t think it would be worrisome if the index breaks through 1100 and falls a bit short of 1120.

Of course, things almost never seem to be equal. In today’s case, the complicating factor is that the dollar seems to be beginning another bout of weakness. While downward movement of the currency represents a substantial loss of wealth to holders of US dollar assets (government bonds are especially badly hit), it does affect the economy in much the same way a decline in interest rates does–as a stimulus to activity. And it also gives a shot in the arm to the members of the S&P who have foreign revenues and assets. On balance, I think a lower dollar means an overall stock market that’s higher than it would be otherwise.

It’s also worth noting that the business cycle-sensitive and foreign-oriented stocks have resumed their outperformance, after a pause during the last half of last month. I’d expect this bullish pattern to continue.

November 1, 2009

Happy Halloween, a day late!

The S&P 500 briefly touched 1100 just after the October 14th post below–but it has been pretty much downhill from there through month end.

To evaluate what’s going on, it’s never wrong to go back to the most basic assumptions.

1. It’s increasingly clear, both from economists and from company managements, that the worst of the downturn occurred in the middle months of 2009. The world economy–admittedly with the UK and the US in the caboose–has begun a cyclical upswing that will likely last several years. This economic strength will become increasingly supportive of company profits. Therefore, we’re in a cyclical bull market–meaning the trend direction for stock markets is up.

2. Upward trending markets always have a two-steps-forward, one-step-backward character. Numbers for recent peaks and troughs are in the October 14th post. So far, the movement of the past two weeks is virtually identical to the market action during the second half of September, but from a higher starting point.

I think the key tactical level for the market now is 1019, which it reached on October 2nd before reversing course. Unless/until the market breaks through that low, I think we have to regard the drop of the last 10 days as “normal” market action, even in a bull market.

In my experience, it never pays to become obsessed with the shape of any one of the trees in the forest. Still, I thought trading on Friday the 30th was a bit unusual. It was a sharply down day, with the stocks of economically sensitive companies being particularly hard hit. It was also the final day of the fiscal year for almost all mutual fund companies. No accountant likes to have unsettled trades hanging over from one year to the next, so it’s a day when mutual funds are more or less out of the market.

Mutual fund yearend selling (see my post on this topic, if you’re interested) , assuming that’s what has been driving the current market downdraft, has been pretty mild this year. But mutual funds should have had their selling completed by midweek and shouldn’t have been dumping stocks out of their portfolios on Friday. Maybe that’s the point, though. Maybe short-term traders realized that many natural buyers would be more involved in preparing for trick-or-treating than in looking for cheap stocks to buy. We’ll see on Monday.

October 14, 2009

The S&P 500 has generally been showing a pattern of higher lows and higher high since the market bottom in March. This progress was interrupted for about a month starting in mid-June, but resumed in the second half of July. The numbers are as follows:

Aug 7 high 1018

Aug 17 low 978

Aug 28 high 1039

Sep 2 low 992

Sep 23 high 1080

Oct 2 low 1019

Surprisingly, the seasonal mutual fund selling which normally makes September-October a weak period for the market has not yet shown itself. Since portfolio managers are often politely asked to refrain from trading during the last week of the year, to make the accountants’ book closing task a little easier, there isn’t much time for it to happen.

Over the past week or so, the S&P has shown signs of stalling around the 1080 level. This might signal the beginning of another correction like the one we had in June-July. Very strong earnings reports, however, may propel the market decisively above the 1080 level. It will be interesting to see if the market can close above 1080 today on the strength of strong earnings from INTC and JPM.

September 7, 2009

This morning Kraft announced a $16 billion + bid for Cadbury, the UK-based chocolate and chewing gum maker. This follows a week in which Disney bid for Marvel Entertainment, Baker Hughes bid for BJ Services, an arm of the Abu Dhabi government agreed to buy Chartered Semiconductor and Dainippon Sumitomo bid for Sepracor.

The first three contain the most positive news for the market, in my opinion. Who knows what the motivations/skills of sovereign wealth funds are? And for years, the growth and profitability of Japanese drug companies has all been in the US–acquisitions like Sepracor, which have been going on for a while, just represent the latest evolution of Japanese thinking on this topic.

But the first three bids are important because they are all by trade buyers whose companies have considerable sensitivity to the business cycle. Two, Disney and Kraft, are dominant factors in consumer-oriented industries.

Lots of mergers fail to bring anticipated rewards, so we can’t conclude from the bids themselves that they’ll be good for the acquiring companies. But the fact of these bids does imply two important things:

1. The bidders, who have long experience and powerful information systems to take the pulse of their markets, think we are well past the worst in this economic cycle. They would never take the risk of major acquisitions otherwise.

2. The bidders also see fundamental value and think prices won’t go lower. This is much more a judgment call than #1, where the firms likely have substantial concrete evidence from their IT systems. Still, it’s nice to hear.

August 16, 2009

When investors have exhausted all other possible avenues of inspiration, or maybe when they can’t find a recent copy of People magazine or if ET isn’t on yet, they often go over the charts of past bull or bear markets looking for patterns that may be applicable to the current situation.

One often proposed analogous time period to today is the time from mid-1975 to early 1978, when the S&P meandered a lot without going much of anywhere. There is some attractiveness to the comparison. The bear market we have just ended was bad enough to be matched only by the 1973-74 downturn. The role of the dollar as the world’s reserve currency was being called into question then, as now. And inflation would ultimately prove a greater threat in the Seventies than commonly thought.

So far as I can tell, however, this period is being singled out mostly (solely?) by people who didn’t live through it, and who don’t realize what a fabulous period for returns this was for holders of anything but a small group of fading stars of the early Seventies like Kodak or Xerox. This was the period when many famous growth stock investors cut their teeth and when its spectacular Magellan Fund rescued Fidelity from the firm’s missteps of the Sixties.

Anyway, I think a return of 1976 would be incredibly bullish for individual investors. That’s not the period that catches my eye, though. I think today looks more like late 2003. Like then, we have had a sharp rebound off a bear market low. The interest rate environment is similar. From a chart point of view, the next concentrated area of buying and selling is maybe up 20% and it’s not so clear that we’re going to get there in a hurry.

What followed 2003 was 2004 (great insight!) another period of meandering around that delivered single digit market returns. Most stocks did nothing. But it’s also the year AAPL and MON really got going.

The key to 1976-77 was not so much what you decided to buy but to make sure you avoided the largest cap stocks. In contrast, I think the key to next year will be to find the hot spots of growth in an overall so-so environment.

July 24, 2009

Technicals

The market has answered one technical question–will the 880 level form a floor for the S&P 500?–in the affirmative, only to be surprisingly quickly confronted with another–is the 950 level a ceiling or a new floor for the S&P?

My guess is that 950 ends up being a new floor, although the next few trading days will make the situation clearer. Where is the new ceiling? Maybe 1050 or so, but, again, near-term trading will provide more information.

I still think a reasonable, and conservative, target for the S&P at yearend is at the same level, around 1050. But it could be higher. It’s also reasonable, though, at this point to ask what comes afterward. I think the next objective is the 1200-1300 area, or about where the market was before Lehman went into bankruptcy late last year.

Earnings season

The third quarter earnings season has gone much better than analysts’ expectations so far. This comes from a combination of three factors:

many experienced analysts have been laid off, leaving less-skilled successors in charge;

analysts understood that, unlike the situation today, investors a couple of months ago wanted to hear how bad things might get, not how good they might be. This means analysts realized they had little to gain by putting out anything but very low estimates. They may have been constrained, too, by the overall gloomy view of their strategists/traders. The same goes for the guidance about earnings that companies gave to analysts;

almost any company has a high degree of operating leverage when revenues are falling, so earnings are especially difficult to estimate in this situation.

The message from earnings reports has varied among companies but the earnings surprises seem to come, again, from three causes:

for a few companies like Apple, genuinely strong earnings growth. Here, the reason is that firms with stronger products are taking market share away from those with weaker offerings.

Where to from here?

The consensus view is that we are now at the bottom of the cycle economically and that recovery from this level will be slow, patchy and difficult. I think this is probably true, even though the resilience of Americans and the American economy has always been underestimated.

The consensus has taken this to mean that there will only be slow upward progress for individual stocks and for the index as a whole from this point. As a general principle, we should assume that this consensus view will prove to be incorrect (the consensus always is in the US). The real question investors have to answer is how the consensus will be incorrect.

My guess remains that today’s market will play out in broadly similar fashion to the second half of the Seventies. That is, the index won’t be anything to write home about but there will be a sharp separation between winning and losing stocks. Failing to recognize this is where the consensus will be wrong.

There will continue to be market share gainers, like Apple, who advance at the expense of their associated share losers, like Dell.

In addition, the world will be divided into those who have been seriously wounded by the financial crisis and those who have not. China vs. the US and the UK might be one winner/loser pair. Those under thirty vs. older Americans might be another–this may be the point where the Baby Boom definitively turns over the baton of market leadership to Gen X or Y.

Small companies vs. large may be a third. Yes, small has done well since March, but I read this as being as much the dynamics of supply and demand for smaller stocks at market turning points than genuine investor conviction that this is an important place to have money for the next several years.

July 13, 2009 (after the market close)

This was another peculiar day on Wall Street. News flow has been generally positive over the past week, but the market hasn’t wanted to pay attention. The World Bank raised its economic forecasts for the world, both for 2009 and 2010, for example, but this made only a fleeting positive impact on sentiment. Investors instead wanted to focus on near-term negatives that they would have shrugged off without thinking about a month ago.

After bouncing around the 880 level on the S&P 500 for several days, hitting 869 intraday on July 8th in the process, the market declined early this morning to touch 875 before rebounding to close up 2.5% for the day at 901.

What caused the upward move? Apparently a bank analyst, Meredith Whitney, who has been unremittingly, and correctly (until March) bearish throughout the banking crisis, made positive comments about the banks today.

I don’t think the comments themselves–that after tripling and more since March, banks might have another 15% upside in the near term–were that bullish. Wall Street generally believes that analysts who have been spectacularly right in their predictions tend to ride those predictions long after circumstances have changed. When the pain of having missed the turn upward finally forces the bearish analyst to shift away form the former stance, the market usually takes this as the last bear capitulating–and, in its usual perverse way, takes this as the cause for a selloff in the group.

I take two positives from today: contrary to what one might expect, the Whitney comments fueled a strong rise in her group and in the market in general; also, the market bounced strongly off the 880 level end closed above 900.

July 6, 2009 (after the market close)

Today was potentially an important day for Wall Street, and by extension, for the rest of the world.

A rolling correction through market-leading stocks has been occurring over the past week or so. It has been putting downward pressure on the overall market as well.

From around the beginning of June the S&P 500 has been testing the mid-880 level and bouncing above it on each occasion. Today looked for a while as if it would be the first day when the bears would leave the field victorious. The market had declined sharply on the final trading day of last week and closed on its lows. Despite early good news about the progress of the service economy, the market went sharply lower again this morning.

But the market bounced off its 886 low of about 10:30 am and closed at 898. Trading over the next few days will bear watching, but it looks as if the market has once again successfully tested the 880-level resistance.

Where do we go from here? The optimistic, and, I think, more probable case, is that the market bounces along at around this level until second-quarter earnings reports give us more information about the course of the economy. The more pessimistic case is that the market has a repeat, on a much smaller scale, of the panic of February-March. In that case, we may break down below 880 and settle in the low 800s before moving sideways.

Why less probable? Two reasons: there is a ton of money on the sidelines, and it’s hard for people chastened by seeing the folly of giving in to their early-year fears to do it again so soon after.

June 7, 2009

It’s one of the iron laws of stock market investing that the market acts so as to make the greatest fools out the largest number of people.

A corollary is that you can bet the farm on the market rising until the last bear capitulates (and turns bullish).

What, then, should you make out of this story from marketwatch.com? (I find the quote from The Chartist at the end of the article particularly interesting–in other words, I think he’s right.) In it, Mark Hulbert, who tracks the performance of investment newsletters, reports that the one with the best record since 1980 has turned aggressively bullish.

One point would be that there are still plenty of bears. Another is that The Chartist had previously been correctly bearish. This kind of change is very unusual, in my experience. People normally become so enamored of their own correctness that no new data gets in and they find it impossible to respond to changing circumstances.

All in all, I find the story relatively encouraging. Myself, I think that there are lots of stocks that will rise in the coming year. If the overall level of the stock market rises as well, so much the better.

June 2, 2009

The S&P spent the month of May bouncing above the 890 level. The correction that many commentators had called for did not develop. It looks as if the 890 level has turned from resistance into support.

The story of the month for the US market is not so much the 5% index gain, but, just as in March and April, the strength of cyclical sectors and the relative weakness of defensives, like utilities, health care and consumer staples.

Also not much talked about is the 13% gain in dollar terms for non-US developed markets, as measured by the MSCI EAFE index (Morgan Stanley Capital International Europe Australia and the Far East). This comes in spite of a 7% rise of the euro, and a 3.7% rise of the yen, against the dollar This is unusual. Typically a rising currency tends to hold a market back, so this will be something to watch in the weeks ahead. But it may also well be that this is an early warning that the US is reverting to the status of a laggard market, a position it held through the Seventies and Eighties.

Bears appear to have two points: that the markets have come too far too fast, since economic recovery is unlikely before next year; and, the US will have to undergo a period of subpar growth as consumers who have outconsumed their income repay borrowings rather than buy new things.

I think the first point is a legitimate concern, although the first economists are beginning to suggest that recovery is possible as early as the end of summer. The second point may also be correct, but I think it has limited relevance for stock investors. I still haven’t sat down to write about this at length, but I think there will be plenty of money-making opportunities in the year ahead from focusing on technological innovation, companies with a global marketplace, and companies that service under-forty consumers. Derivatives may not help much in reaching these areas. Finding individual stocks will.

May 11, 2009

Sell in May and go away?

I’ve always thought of this as a European maxim, the idea being that factories basically shut down in Europe during the month of August and everyone, including stock market participants, goes away on vacation. In anticipation of this lull, suppliers of industry–from raw materials to electronic components–gear down as well, only a couple of months earlier. So revenues flag from about May on, and no one gets a good read on the strength or weakness of the European economy until September.

There’s a similar phenomenon, though smaller, in Japan during August, as Obon and the annual high school baseball tournament cause breaks in work during the month.

In the US, the only analogue I can think of is the claim that tech stocks follow the rhythm of tech conferences, which are normally held during the spring and fall. So no news to move the tech market from May to September means no reason to bid the stocks up, therefore they (probably) go down.

Of course, this is not a “normal” year, so even if this stuff usually applies, it probably doesn’t now. Industrial production has already suffered a significant slowdown. Although stocks have had a huge rally, the S&P is barely up for the year. Also, it’s not clear to me that many people timed the rally perfectly and have large trading profits they want to realize.

Still, news services seem to be predicting that a correction is imminent. And one may appear, though not for the Sell in May… reasons.

(An aside: I attribute the sharp decline early in the year to worries that Washington was so far out of its depth in dealing with the credit crisis that the doomsday scenario espoused by perpetual bears might–for the first time since the 1930s–actually happen. I don’t think Wall Street has any higher opinion of Congress today. I think the rally sprang from signs that credit markets were beginning to unfreeze, consumers were not as fearful in March as they were in November and the administration had figured out ways to circumvent Congressional roadblocks.)

If/when a correction comes, it will give some information about the mood of the market–how eager are investors to put new money to work? how will the stars of the rally–sectors that thrive in an expanding economy–perform? Other than that, I don’t think the fact of, or the shape of, a correction is the main issue facing the market today.

What is the big issue? It may be true that the US will have a sub-par recovery from the current economic downturn. But I think the consensus is mistaken in concluding from the possibility that the indices won’t rise much that there won’t be large money-making opportunities anywhere.

I’m going to write about this in greater length in the next week or so, after I finish posts of China and ETFs that I’ve been working on. Briefly, though, I think the recipe for success is New Economy over Old, plus staying away from the beneficiaries of the financial/housing boom that ran through mid-2007.

April 27, 2009

SARS and Swine Flu

World markets are selling off this morning in reaction to announcements over the past several days of an outbreak of swine flu. Apparently originating in Mexico, the virus has already spread to several states in the US, to Canada and to Europe. Although this flu seems to be far less deadly than SARS, fatalities have been reported.

This new flu epidemic is, first and foremost, a human tragedy. To try to gauge the effects that the possibility of a new flu epidemic might have on world stock markets, though, it might be useful to review how the SARS episode of November 2002-March 2003 played out.

SARS spread from southern China in late 2002. According to the World Health Organization, 8422 cases of SARS were ultimately reported, the majority of them in mainland China and Hong Kong. Of that number, 916, or well over 10%, died. At least initially, treatment for SARS was a difficult experience and recoveries were often incomplete. The mainland number, 5327, may also be a significant understatement, since China initially denied that the epidemic existed and refused to release information about it. Pressure from ordinary citizens in Hong Kong, where 1755 cases ere reported, was what finally compelled the government there to publicize the outbreak.

It took about four months after the initial non-mainland cases of SARS occurred for the world to begin to believe that the epidemic had been contained. For about half that time, I think, global investors were at least vaguely aware that SARS existed but regarded it more as an Asian problem than as a threat to world economic activity.

During the SARS epidemic, many Asian countries screened both incoming and outgoing passengers with heat sensors for elevated body temperature, and quarantined those who failed the test. According to the Wall Street Journal, this process has started again in at least Hong Kong, Taiwan and Japan.

From November 2002 to March 2003, the Hang Seng index in Hong Kong declined about 20%, vs. a 10% fall in the S&P 500.

Two sectors were especially hard hit:

Travel–Business travel to the affected areas slowed markedly. Some people may have worried about contracting SARS. But I think the greater fear was that the situation might deteriorate while on the road and that the traveller either wouldn’t be allowed back into his home country or would be quarantined on arrival.

Manufacturing–Factories would be shut down and workers quarantined if SARS were detected in the workplace. This prospect had two opposite effects. Factories that were temporarily closed meant lost output–and lost components and end products for customers. On the other hand, fearing this possibility, customers urged factories to increase production and stockpile enough output that the supply chain could withstand an extended factory shutdown.

How this epidemic differs from SARS:

–flu epidemic is now a familiar scenario to world stock markets, so the (negative) reaction by markets has been immediate. The key issue is, of course, whether the epidemic can be contained. At this point, and we’ll know better in a few days, my guess is that the market selloff will sharp but short.

–epidemic is also a familiar scenario to world health authorities, so preventative measures are going into effect quickly. Information is much more available today, in contrast to the foot-dragging by China during SARS. Also, we have stockpiles of anti-flu medicine, which were unavailable then.

–the center of the outbreak is North America, not China. We have the same issue that infection is spread where people come into close contact. This is a problem for any manufacturing and also for big cities. But for the service sector, especially in the post- 9/11 world, US firms have some ability to work away from cities and collaborate through the internet.

What to do? I don’t think we have any reason yet either to buy or to sell. SARS was a four-month phenomenon that occurred at the tail-end of a global down turn and caused a 10% relative decline in the affected markets. Transportation, lodging and manufacturing were the worst hit areas. Chances are that this won’t be as bad, which would argue that a market decline is a buying opportunity. But we won’t know that for a while yet.

April 22, 2009

World stock markets continue to shrug off a large amount of bad news and to focus almost exclusively on positive corporate and macroeconomic data. This is an encouraging sign.

It is even more remarkable when you consider that the positive news is not that the world economy is beginning to turn up, or even that it has stopped falling, but rather just that it appears to be gliding in for a landing at a relatively low level. True, some economists are beginning to call for a resumption of growth as early as the September quarter, but they’re in a minority so far. Personally, I feel more comfortable saying growth starts again with the new year. Still, I think the market is saying that prices just aren’t going to get much (any?) cheaper than they are now, so a decline on disappointing near-term earnings is a chance to buy.

Charts (which are not my favorite things): When longer-term charts are filled with a lot of activity around a given price level, like there is at about 820-830 on the S&P 500, it’s psychologically (technically) important. When this level is above the current price, it forms a ceiling or “resistance” to a further advance. When the price breaks through this level, the level itself changes into a floor or “support,” below which the price may have a hard time going. My guess is that the pattern of lower daily Wall Street openings and flat/higher closes is short-term traders testing this floor and finding that it is holding. The longer this goes on, the more secure the floor will be.

I still think we’re going to reach 100 on the S&P by yearend. I don’t know how we get there, though. But I do think the market will continue to favor cyclical stocks from this point on, as it has been doing for some time. During this pause in the market, I think investors should continue to build the cyclical tilt to their portfolios.

April 15, 2009

See my blog posts on Shaping a Portfolio for 2010–Individual Stocks

April 10, 2009

WFC as a straw in the wind

At the beginning of this week, I was thinking to myself that it might be AA who would report dismal earnings vs. analyst consensus estimates and perhaps give a clear sign of the market tone. The messenger of investors’ mood out to be WFC instead.

WFC announced yesterday morning that its March quarter eps would be $.55 a share, more than double the consensus of $.25. Several aspects of this announcement are interesting/important:

1. WFC “pre-announced” the earnings. That is, it made the number public in advance of the scheduled earnings release. Why did it do this?

–to send a strong signal that this was important news;

–to make sure that the numbers didn’t somehow leak out before the official release;

–(I think) to make a political statement (more below).

2. Analysts stated long and loud that their “miss” was due to WFC having much lower loan loss provisions than Wall Street thought appropriate.

3. The market didn’t care about the analysts. The stock went up over 30% on the news.

What now?

What do we do now? First, put the market in perspective. Yes, we’ve had a great run over a few weeks. But we’re still down year-to-date on the S&P. So if this is truly the start of a new bull market, then we’re still in the first inning.

We’ve climbed out of the hole created when investors began to think that the banking crisis was so large, and Washington so inept, that the problem wasn’t going to get fixed. (As you may recall, during the recession of 1990, learned commentators said the American industrial base was so dominated by Japanese competition that it would never recover, and that our only future source of foreign exchange would be to hire out our armed forces as mercenaries. But Saddam Hussein would prove such a formidable foe that even this must be called into question.)

Anyway, where to from here? After the decline following the demise of Lehman last fall, the market rallied in October to about 1000 on the S&P 500. I think it’s a reasonable–modest may be a better word–goal to expect to get back to that point by yearend. That would be a gain of over 15%. If we now decide to think the S&P won’t fall as low as 745 and posit instead that it could get halfway there (technicians always seem to use the “magic” fractions of 1/2 and 1/3), then our downside would be about 5%. So, if any of this is true, the odds are in our favor.

The previous paragraph, pathetic as it is, might have been enough to go on when we were in the 600s. That’s because when the market turns there’s a mad rush to get money back into the market and everything goes up. You may be noticing, on Google Finance or elsewhere, that on up days everything goes up, even though the economy-sensitive sectors are the strongest performers.

Next phase of the market

After a while that surge ends. You might have noticed yesterday, for example, that health care and utilities barely moved, in a market up close to 4%.

In the next phase, a mindset I think we should be adopting now, even if the market isn’t quite ready for it yet, the focus is much more heavily on the winners in the next up cycle. In other words, having a coherent–and reasonably correct–strategy become crucial.

More about this in future posts.

A pre-announcment message?

The WFC political statement? I should say, first of all, that I don’t know much about WFC, other than it has been much better managed than most other banks. But reading and hearing their recent public statements, it strikes me that they think they are being treated unfairly and are mad about it. I think they feel that last year the government came to them and implored them to make a patriotic sacrifice and rescue a bankrupt competitor. They agreed, even though this was something that wasn’t necessarily forst on their “to do” list.

No sooner had they done this than the terms of the rescue plan were retroactively changed in a way they had no say about, top management was were vilified in public, Congress started to micromanage their business, and Wall Street started to suggest that WFC had much larger risk in its loan portfolio than the management understood.

So the timing of the earnings announcement seems to me to be saying: to Wall Street, “we understand more than you do about our loan book,”; to Congress, “we’re fixing the problem you made and then saddled us with, so don’t botch up what we’re doing by telling us how to do our jobs”. In the early returns, at least, investors seem to be lining up on WFC’s side.

April 6, 2009

Today was another in a series of resilient days that the market has strung together.

It seems to me there are three characteristics of a bear market, other than that the up days (usually a majority of trading days are up) are little more than flat and the down days are wickedly bad. They’re:

1. the market ignores good news and focuses only on the bad;

2. the market discounts the same bad news over and over and over again; and

3. the market is solidly anchored in the present and refuses to look ahead to potentially different (and hopefully better) economic circumstances.

I’m finding it harder to see evidence of the bear market mentality in recent trading. I’m figuring that, when it comes, the recovery will be sub-par and it likely won’t arrive until New Year’s Day. So I don’t want to get carried away (but what I’ve just written is so the consensus that it worries me a little). The 10% correction I’ve been envisioning doesn’t seem to want to materialize, despite being given the opportunity over the past week. And stocks like RIMM (my family owns it) seem to be able to sustain investor enthusiasm.

The next milestone to watch will be how seriously the market takes the earnings numbers that companies report for the December quarter, especially for firms that come in below the Wall Street consensus. Everyone knows the earnings will be bad, and that the current quarter will be only a little better. I don’t imagine many CEOs will be willing to go out on a limb and assert that economic improvement will accelerate. There may be a few black holes but I don’t expect to hear much that the market isn’t already aware of.

Everyone also know, or should know, that quarterly earnings during a bad period are almost impossible to estimate for companies with a lot of financial or operating leverage. Small changes in customer or supplier behavior can make a big difference. Long-term contracts may compel actions the company doesn’t want. There may be complex materials hedging arrangements or any of a long list of other things that an outsider doesn’t have information about. The final quarter of the year is especially complicated because firms have to square up tax payments and inventory levels that they’ve been estimating in earlier quarters.

Anyway, if a company reports a loss of, say, $1.50 a share for the quarter vs.analysts’ estimates of a $1 a share deficit, will the market shrug this off as just one of those things? That would be very bullish. Or will the market ignore the fact that the analysts’ best guesses are subject to large uncertainty and sell the stock down severely? That would tell us the bear isn’t as dead as I think.

April 2, 2009

Yesterday was an extremely strong day. Volume remained high.The pro-cyclical tilt of the market remained. Most interesting to me, though, was the very strong performance of highly leveraged (operationally as well as, in some cases, financially) consumer cyclicals–stocks like hotels. This performance is a lot stronger than I expected when I wrote on March 30th. We may still have a pullback at some point. But it will likely be milder than I thought, both in the depth of the downward move and its duration. There’s a good description of the behavior of investors in the early stages of a bull market in John Train’s Preserving Capital, in the chapter “The Dance of the Bees.”

Also, RIMM’s results merit a look–very strong new business subscribers.

April 1, 2009

The market the past couple of days has been stronger than I would have thought.

Going back to the lows of a few weeks ago, I could imagine a trader saying to himself, “The market may have some downside, but it’s not much, maybe 5%, and if we could get back to where we were just a few weeks ago, that would be up 30%. So I could gain 30% or lose 5% on the market’s course over the next month or two. And so far as I can tell, the chances of one happening rather than the other aren’t much different. So I’m getting tremendous odds now for betting that the market will go up.”

For that trader, the situation would be different last week. By then he had made 30% and would be thinking, “The market has meandered around 850 for months and there has been a lot of buying and selling around that level. That will be hard to break out to the upside, and it’s only about 5% away from where we are now. I can imagine the market dropping back to the November lows of around 750, so my downside is 10%. I know the chance of a pullback is much higher than the chance we continue above 850. So I should sell.”

We did get as low as 779 intraday before reversing field and having two up days, despite the release of a lot of bad economic news. I still think 830 is a formidable barrier. But the market action of the next few days bears close watching.

The question is whether it’s correct that we still have some months to finish positioning a portfolio for a rising market.

March 30, 2009

The upward move in world stock markets appears to me to have run out of steam for the moment. The S&P 500 has recovered virtually all the ground it lost in February and early March, but seems to have encountered trouble moving higher.

Markets rarely stand still, however. So if the market is unable to go up, then it will begin to go down. If so, we should see the interplay of two opposing forces–short-term traders, who will be trying to figure out how low the market is willing to go; and longer-term investors, who will (I think) be thinking of any pullback as an opportunity to put more cash to work in stocks.

In the early stages of a “normal” bull market, this interplay typically results in a jagged, two-steps-forward-one-step-backward pattern of higher lows and higher highs. In our case, I don’t think the up move is based on any sense that earnings growth is about to resume for publicly-traded companies. I think panic has subsided about the general cluelessness of Congress about the banking crisis, and at the same time, companies are signalling that the economy isn’t turning out to be quite as bad as they thought it would a couple of months ago. My guess is that there’s enough good news to establish a trading range between 750-830 for the time being.

In this trading range, we should see investors continuing to reshape their portfolios in a more aggressive direction. This is a far more important process.

Some market commentators are arguing that we have to go back to test the lows of early March. I don’t think so, for two not entirely satisfactory reasons.

First, panic of the type that marked early March is very exhausting psychologically. So it’s difficult to sustain for a long period of time, and it’s difficult to duplicate again soon.

Second, if investors do in fact want to add to their stock market exposure, they will have a target in mind, say, S&P at 700, where they think stocks would be very attractive. But if everyone wants to buy at 700, then someone will begin to buy at 715, arguing that a premium of 2% is well worth it, if he can be sure of buying whatever he wants. Since everyone in the market understands this mechanism, then either stocks never get to 715 or the first buyer sets off a torrent of purchasing that pushes stock back up.

It looks like a turning point is here…

When the market turns, sentiment changes long before the fundamentals. In a bear market, investors discount (factor into stock prices) any negative information they hear, while ignoring the positive. In a bull market, in contrast, investors embrace the positive and ignore the negative. Most analysts and media reinforce this tendency by giving investors a steady diet of whatever they signal they want to hear.

A few weeks ago , we reached (I hope!) a crescendo of negativity, with analysts trying to outdo each other with ever more dire predictions, and newscasters tyring to identify the signposts that would redefine the current downturn as depression rather than recession. At the same time, not only was the S&P on a relentless decline, but it also broke through the lows of November 2008.

..if only in the market’s mood.

Maybe it’s the approach of spring, or the arrival of daylight saving time, but the mood of the market has changed markedly over the past week or so. True, we still have the same daunting problems with the financial system that we had 14 days ago, and it will doubtless be the same long, hard slow we had been anticipating then for the world economy to a respectable rate of growth. But a lot of anecdotal information has come out in the past weeks that the US economy was at its worst last November-December and is doing a bit better now. This news is being reported. And, most important, investors seem to be choosing to tune this information in, rather than out.

The trading pattern of the past six days has also been instructive. We know the major banks are in their own world. Citibank, for example, is trading at $2.50 a share, up by over 150% from its recent low–but still down from $7 at the start of the year. So let’s leave the financials aside.

In the rest of the market, on most days trading has not been dominated by one industry group. Instead, almost everything is up. Stocks that are the most sensitive to the business cycle, such as technology, transport, consumer cyclicals, industrial materials, have been the strongest performers. Small and mid-sized companies, which suffer the worst in any credit contraction (you’ll never get fired for lending to IBM, but you can for lending to Joe’s Garage, no matter how wonderful Joe’s business is now that no one’s buying new cars), are doing at least as well as their larger brethren.

I’m not saying we’re out of the woods yet. Wall Street has been stunned to find out how little the financial statements of many banks have resembled reality. This revelation comes less than ten years after a major accounting scandal that not only involved Enron but also touched aging icons like GE and IBM. That scandal resulted in a major shakeup in the accounting profession, one which, we thought, would provide us with more reliable financials. …oh, well.

The market seems to be regaining its bearings.

I think what we are seeing now is the market regaining some of its equilibrium, its ability to think rationally. I suspect that professional investors are still trying now, and will continue to try, to apply rules of thumb derived from experience of traditional recessions to the current situation. This, along with bank-related panic, may have caused Wall Street to initially overestimate how bad the damage was. Past experience may now cause Wall Street to underestimate how long this recession will be.

An end to panic would be a big plus.

In any event, the end to panic would be a very positive thing. Stocks are unusually cheap. The flow of credit is, in fits and starts, beginning to accelerate again. Whether today or tomorrow are up or down days isn’t that important. What is important is that we can get back to work again analyzing companies, with greater confidence that if we draw correct conclusions about company profits we will be rewarded for doing so.